the strategic management process

environmental scanning

ANALYSIS OF INTERNAL RESOURCE BASE AND ENVIRONMENT

•      Contents:

•      · Value chain analysis

•      · Strategic group concept

•      · Benchmarking

Value chain analysis:

•      Describe the value chain of a firm and its significance in strategic planning

•      This concept was propagated by Michael Porter as a tool of analyzing the firm’s internal environment and resource base.

•      It is an analytical tool that describes all activities that make up the economic performance and capabilities of the firm, used to analyze and examine activities that create value for a given firm.

•      A firm can be conceived of an aggregation of discrete activities and the competitive edge arises based on how a firm performs these activities better than its competitors. The cluster of these activities is called the value chain.

•      The value chain classifies each firm’s activities into two broad categories: Primary activities and Secondary activities or support activities.

Primary activities

•              Primary activities: The sequence of activities through which raw materials are transformed into benefits enjoyed by the customer is called primary activities.

•      These activities relate directly to the actual creation, development, manufacture, distribution, sales and servicing of the product or the service to a customer.

•      Five major activities are involved in this sequence: inbound logistics, operations, outbound logistics, marketing and sales and service.

•      Working together, these activities determine the key operational tasks surrounding the product or services.

•      · Inbound logistics : As the word implies, inbound logistics deal with the handling of raw materials and inventory received from the firm’s suppliers.

•      Detail activities include Receiving, storing, materials handling, warehousing, inventory control, vehicles scheduling and returns to suppliers.

•      · Operations : Operations are the activities and procedures that transform raw materials, components and other inputs into finished end products.

•       Detail activities include machining, packaging, assembly, equipment maintenance, testing, printing, facility operations.

•      · Outbound logistics : Outbound logistics refers to the transfer of finished product to the distribution channel members.

•      The focus of outbound logistics is on managing the flow and distribution of products to the firm’s immediate customers such as wholesalers and retailers.

•      Activities and procedures associated with outbound logistics include inventory control, warehousing, order processing, delivery schedule maintenance etc.

•      · Marketing and sales : Marketing and sales include advertising, promotion, product mix pricing, specifying distribution channel members, maintaining channel relations etc in order to induce and facilitate buyers to purchase the product.

•      · Service : Customer service is a central value adding activity that a firm can seek to improve over time.

•      It includes installation, repair, training, parts supply and product adjustment in order to maintain or enhance the value of the product after sales.*

Secondary or support activities:

•      The remaining activities of the value chain are undertaken to support primary activities.

•      They are therefore referred to as the secondary or support activities.

•      Support activities help the firm improve co-ordinations across and achieve efficiency within the firm’s primary value adding activities.

•      This includes, procurement, technology development, human resource management and firm level infrastructure:

•      · Procurement: Securing inputs (such as raw materials, supplies, and other consumable items and assets) for primary activities.

•      · Technology development: Methods of performing primary activities are improved (Such as know-how, procedures, technological inputs needed)

•      · Human resource management: Employees who will carry out the primary activities are recruited, trained, motivated and supervised.

•      · Firm infrastructure: Activities such as accounting, finance, legal affairs, and regulatory compliance are carried out to provide ancillary support for primary activities.*apbs

How value chain analysis matters in strategic planning:

•      As already stated, the competitive edge arises based on how better the firm performs the activities involved in the value chain compared to its competitor.

•      For this purpose, each activity is broken up in sun activities for comparison with the competitors, and three basic questions are tried to be answered

•      i) How can the firm keep the benefits provided to the customers intact keeping the cost constant?

•      ii) How can the firm increase the benefits provided to the customers keeping the cost constant?

•      iii) How can the firm increase the benefits provided to the customer while lowering the cost?

•      For creating competitive advantage through the value chain analysis, while answering these questions, Porter has suggested the following measures:

•      · Reconfigure the value chain differently from those of the competitors.

•      · Perform the activities more efficiently than the competitors.

•      · Outsource the non-core activities: While outsourcing the following points are needed to be judged judiciously:

•      i) There might be a risk of non-performance by the supplier, To avoid this, ways of keeping alternative suppliers, Tapered integration and part outsourcing can be adopted.

•      ii) There might be a risk of disproportionate value appropriation

•      iii) There can be a high risk of elimination by suppliers.

•      · Internal integration of value chain activities: Internal integration of value chain activity gives the following benefits…

•      i) Improvement of quality

•      ii) Shorten new product development cycle.

•      iii) By integrating the firm with its external suppliers and buyers it can reduce inventory holding costs, enhance the ability to customize the product and become more responsive to customers’ demand**

Strategic group concept

•      Strategic group is a group of firms within an industry which face the same environmental forces, have same resources and follow similar strategy in response to the environmental forces.

•      To carry on the value chain analysis it is very important that the firm identifies the strategic group to which it belongs.

•      Porter suggests the following dimensions to identify differences in firm strategies within an industry: i)specialization, ii) brand identification, iii) a push versus pull marketing strategy, iv) vertical integration, v)channel selection, vi) product quality, vii) technological leadership, viii) cost position, ix)service, x) price policy, xi) financial and operating leverage, xii) relationship with parent company, xiii) relationships with home and host government.

•      We should try to locate in the same group all firms with comparable characteristics and following a similar competitive strategy

•      Essentially the concept of strategic grouping is a very pragmatic approach aimed at cataloguing firms within an industry in accordance with the way they have chosen to seek competitive advantage.

•      This segmentation is useful when one faces a high diversity of competitive positions in a fairly complex and heterogeneous industry.

•      Typical examples of this situation are global industries with a wide variety of players, some being totally international and some purely local.

•      Though according to Porter, move from one strategic group to another is very difficult, because every strategic group creates its own image in the market place, the following points should be kept in mind:

•      Strategic groups can shift over time as the needs of the customers or different technologies evolve in the marketplace. Therefore managers should not assume that membership in a particular strategic group permanently locks the firm into a fixed strategy.

•      With sufficient resources and focus, firms can enter or exit strategic groups over time.

•      Entire strategic groups and the firms that compose them can emerge and disappear over time.

•      Thus as the environment changes, the competitive conditions that define a strategic group may work against the entire collection of the firms, resulting in the groups long term decline if competitive conditions intensify.

•      In recent years one of the more enduring trends that have defined a growing number of industries is the hastening pace of consolidation.

•      Competitors are now seeking to buy or merge with their rivals to limit the effects of fierce price wars that negatively impact profitability. Thus consolidation within and among industries can also markedly redefine the underlying stability and membership of strategic group.**/

Benchmarking:

       

•      Benefits of Benchmarking:

•      · It sparks the creativity of internal people.

•      · The firm can be the frontrunner of implementing practices which was never conceived of in the industry. For example: The “BARCODE” invented by the American agricultural food products association.

•      · Targeting the best, so the firm keeps itself ahead of the other competitors.

Types of Bench marking: three types

•      1. Historical benchmarking: It refers to evaluating the firm’s current performance with the firm’s past performance. The problem here is that the past performance may not be impressive. Secondly, There can be an illusion of big performance. Thirdly, It may encourage more of a bad thing. Fourthly, Competitor performance is not considered in this way.

•      2. Industry Bench marking: It refers to evaluating one own performance with industry data. The major problem here is—getting stuck in the middle. Second, unequal bases of comparison, like comparing apple with orange.

•      3. Functional benchmarking: It refers to finding one activity and finding out the best practice in that in any strategic group or in any industry and upgrade the process to that.***

ANALYSIS OF EXTERNAL ENVIRONMENT

•      Analysis of external environment of a firm is necessary while formulating strategy because:

•      i) It affects the business potential of the firm and therefore its profitability.

•      ii) It influences resource allocation among businesses in a multibusiness firm.

•      When we consider the external environment of the firm, we get two layers:

•      i) Operating environment.

•      ii) macro environment.

 Analyzing Macro environment:

•      Macro environment includes all those environmental forces and conditions that have an impact on every firm and organization within the economy. The main differences between operating environment and remote environment are :

•      a) Forces consisting of macro environment affects all the firm directly or indirectly across the industry.

•      b) The environmental forces comprising the external macro environment are given. A firm cannot do anything or do very little to influence it.

•      For analyzing the macro environment we use two models, PEST (Political, Economic, Social, Technological) and STEEP (Social, Technological, Economic, Ecological, Political)

•      However without adhering to any particular model, we will describe the general environments included in macro environment and their effect on strategy decisions.

Economic environment:

•      The variables included in this environment are GNP,GDP, Distribution of GDP and GNP, Inflation, Balance of payments(BOP), Size of external debt. Let’s discuss them one by one..

•      i) GDP and GNP: GDP includes the market value of the goods and services produced within the country by domestic and foreign factors of production whereas GNP includes the value of goods and services newly produced by domestic factors of production at home and abroad.

•      When a firm is multinational, GDP and GNP gives the level of wealth in a particular country and thus the economic vigor of the country.

•      ii) Distribution of GDP and GNP: How GDP and GNP is distributed across various industry and area is also important because it denotes which industry and which location are important.

•      iii) Inflation:

•      Inflation also poses a big problem because it increases the price of factors of production and thus to survive the firm has to change the price very often.

•      Inflation also affects the firm in the following way: Inflation…> Rise in bank interest rate….> Rise in prime lending rate….> Investment slows down for being costly…>Slow economic growth rate.

•      iv) Balance of payments:

•      BOP also influences the economic environment. Adverse BOP affects in the following way….

                            Adverse BOP

*Import restriction: Cost of foreign raw material goes up/ Foreign companies can’t remit dividend in foreign currency

* Interest rate hike: Business loans get less Attractive             Slow economic growth

•      v) Size of external debt: Size of external debt is also very crucial because this affects in the following way : 

•      High external debt…..>Import restriction…….>Foreign currency gets dearer.*

· Social environment :

•          Analyzing the social environment is also very important in formulating appropriate competitive strategy. The main variables included in this environment are as follows:

·        i) Demographics: Demographics is the statistical variables used to define a population. It influences the firm by dominating the nature of demand, size of working population etc.

·        ii) Social stratification: Social stratification means how the society is divided in different castes, tribes, strata etc. This is very important in case of market segmentation and targeting and designing the product offering according to that.

·        iii) Importance of work and result.

·        iv) Employment as a profession---How people view the work under someone.

·        v) Trust on people--- How much is the mutual trust among people.

·        vi) Individualism versus collectivism

·        vii) Consumer buying process—whether it is simple or complex.

·        viii) Educational level—If it high then tendency to white collar jobs increases.

·        Analyzing social environment is particularly essential because it helps to solve the following problem:

·        1. Mobility of labour.

·        2. How much important is material reward.

·        3. How to meet the social needs in the firm.*

· Political and legal environment:

•      The variables included in this environment which influence the strategic decision are:

•      i) Number of political parties and their ideologies.

•      ii) Form of legal system (Common law, civil law and theocratic law)

•      iii) Laws related to business issues. (Health and safety, employment practice, environmental practice, laws related to export import, group treaties and international business forums)*

· Technological environment:

•      Status of fundamental research, development research and technology are the main variables here.

•      It is important to analyze because it depicts the scope of innovation and infrastructural facilities that a firm can avail.*

Ecological environment:

                 The main variable included here are the:

1.     Status of natural wealth

2.     Flora and fauna

3.      Laws relating to utilization and exploitation of ecological resources.

     This is very much important because it determines to which extent and how a firm can use the natural environment of a country to its own benefits.

ii) Analyzing the operating environment—Porter’s five forces model:

•      Operating environment of a firm refers to the industry to which a firm belongs.

•      According to Michael E. Porter an industry can be defined as “The group of firms producing products that are close substitute to each other”.

•      The intensity of competition in an industry is neither a matter of coincidence or bad luck, rather competition in an industry is rooted in its underlying economic structure and goes well beyond the behavior of the current competitors

•      According to Porter, the state of competition in an industry depends on five basic competitive forces (which is presented in the diagram below).

•      It is imperative to analyze this forces in order to formulate competitive strategy because the collective strength of those forces determines the ultimate profit potential in the industry, where profit potential is measured in terms of long run return on invested capital.

•      Also knowledge of these underlying sources of competitive pressure highlights the critical strengths and weaknesses of the company, animates its positioning in its industry, clarifies the areas where strategic changes may greatest payoffs and highlights the areas where industry trends promise to hold the greatest significance as either opportunities or threats.

•      Let’s now discuss each of these forces one by one:

THREAT OF NEW ENTRANTS:

•      New entrants to an industry bring new capacity, thy desire to gain market share and often substantial resources.

•      Prices can be bid down or incumbent’s costs inflated as a result, reducing profitability. The threat of entry into an industry depends on A) the barriers to entry that are present, coupled with B) reaction from existing competitors that the entrant can expect.

•      These are discussed below:

Barriers to entry:

•         There are major seven sources of barriers to entry which are as follows:

•      i) Economies of scale: Economies of scale refer to declines in unit costs of a product (or operation or function that goes into producing a product) as the absolute volume per period increases. Economies of scale deter entry by forcing the entrant to come in at large scale and risk strong reaction from existing firms or come in at a small scale and accept a cost disadvantage, both undesirable options.

•      ii) Product differentiation: Product differentiation means that established firms have identification and customers loyalties, which stem from past advertising, customer service, product differences, or simply being first in the industry.

•      Differentiation creates barrier to entry by forcing entrants to spend heavily to overcome customer loyalties. This effort usually involves start up losses and often takes an extended period of time. Such investments in building a brand name are particularly risky since they have no salvage value if entry fails.

•      iii) Capital requirements: The need to invest large financial resources in order to compete creates barrier to entry, particularly if the capital is required for risky or unrecoverable upfront advertising or research and development.

•      iv) Switching costs: A barrier to entry is created by the presence of switching costs, that is, one time costs facing the buyer who switches over from one supplier’s product to another’s.

•      v) Access to distribution channel: A barrier to entry can be created by the new entrants’ need to secure its product.

•      To the extent that logical distribution channels for the product have already been served by established firms, the new firm must persuade the channels to accept its product through price breaks, cooperative advertising allowances and the like, which reduce profits.

•      vi) Cost disadvantages independent of scale: Established firms may have cost advantages not replicable by potential entrants no matter what their size and attained economies of scale. The most critical advantages are the factors such as the following:

•      a) Proprietary product technology or patent

•      b) Favorable access to raw materials

•      c) Favorable locations.

•      d) Government subsidies

•      e) Learning or experience curve effect.

•      
Expected retaliation ( Contrived deterrence)

•      The potential entrant’s expectations about the reaction of existing competitors also influence the threat of entry.

•      If existing competitors are expected to respond forcefully to make the entrant’s stay in the industry an unpleasant one, then the entry may well be deterred.

 INTENSITY OF RIVALRY AMONG EXISTING COMPETITORS:

•         Rivalry occurs because one or more competitors either feels the pressure or sees the opportunity to improve position. Intense rivalry is the result of a number of interacting structural forces:

•      i) Numerous or equally balanced competitors: When firms are numerous, the likelihood of mavericks is great and some firms may habitually believe they can make moves without being noticed.

•      Even when there are relatively few firms, if they are relatively balanced in terms of size and perceived resources, it creates instability because they may be prone to fight each other and have the resources for sustained and vigorous retaliation.

•      ii) Slow industry growth: Slow industry growth turns competition into a market share game for firms seeking expansion.

•      Market share competition is a great deal more volatile than is the situation in which rapid industry growth insures that firms can improve results just by keeping up with the industry and where all their financial and managerial resources may be consumed by expanding with the industry.

•      iii) High fixed or storage costs: High fixed costs create strong pressures for all firms to fill capacity which often lead to rapidly escalating price cutting when excess capacity is present.

•      iv) Lack of differentiation or switching costs: Where the product or service is perceived as a commodity or near commodity, price and service competition result.

•      v) Capacity augmented in large increments: Where economies of scale dictate that capacity must be added in large increments, capacity additions can be chronically disruptive to the industry supply/ demand balance particularly where there is a risk of bunching capacity additions.

•      vi) Diverse competitors: Competitors diverse in strategies, origins, personalities, and relationships to their parent companies have differing goals and differing strategies for how to compete and may continually run head on to each other in the process.

•      vii) High strategic stakes: choice by the buyer is largely based on price and service, and pressure for intense Rivalry in an industry becomes even more volatile if a number of firms have high stakes in achieving success there.

•      viii) High exit barriers: Exit barriers are economic, strategic and emotional factors that keep companies competing in business even though they may be earning low or even negative returns on investment. The major sources of exit barriers are specialized assets, fixed cost of exit, strategic interrelationships, emotional barriers and government and social reactions.

THREAT OF THE BUYERS

•      Buyers compete with industry by forcing down the price, bargaining for higher quality or more services and playing competitors against each other-all at the expense of industry profitability.

•      A buyer group is powerful if the following circumstances hold true:

•      i) It is concentrated or purchases large volumes relative to seller sales:

•      If a large portion of sales is purchased by a given buyer this raises the importance of the buyer’s business in results.

•      Large volume buyers are particularly potent forces if heavy fixed costs characterize the industry.

•      ii) The products it purchases from the industry represents a significant fraction of the buyer’s cost or purchases:

•      Here buyers are prone to expend the resources necessary to shop for a favourable price and purchases selectively.

•      When the product sold by the industry in question is a small fraction of buyer’s cost, buyers are usually much less price sensitive.

•      iii) The product it purchases from the industry are standard or undifferentiated:

•      Buyers, sure that they can always find alternative supplies, may play one company against another.

•      iv) It faces few switching costs:

•      Switching costs lock the buyer to particular sellers. Conversely the buyer’s power is enhanced if the seller faces switching costs.

•      v) It earns low profits:

•      Low profits create great incentive to lower purchasing costs. Highly profitable buyers, however, are generally less price sensitive and may take a long term view toward preserving the health of their suppliers.

•      vi) Buyers pose a credible threat of backward integration:

•      If buyers either are partially integrated or pose a credible threat of backward integration, they are in a position to demand bargaining concessions.

•      vii) The industry’s product is unimportant to the quality of the buyer’s product or services:

•      When the quality of the buyer’s product is very much affected by the industry’s product, buyers are less price sensitive. For example: medical equipment.

•      viii) The buyer has full information:

•      Where the buyer has full information about demand, actual prices, and even supplier costs, this usually yields the buyer greater bargaining leverage than when information is poor.

THREAT OF THE SUPPLIERS: (Bargaining power of the suppliers)

•      Suppliers can exert bargaining power over participants in an industry by threatening to raise prices or reduce the quality of purchased goods and services. 

•      Powerful suppliers can thereby squeeze profitability out of an industry unable to recover cost increases in its own prices. A supplier group is powerful if the following apply:

•      i) It is dominated by a few companies and is more concentrated than the industry it sells to:

•      Suppliers selling to more fragmented buyers will usually be able to exert considerable influence in prices, quality and terms.

•      ii) It is not obliged to contend with other substitute products for sale to the industry:

•      The power of even large, powerful suppliers can be checked if they compete with substitutes.

•      iii) The industry is not an important customer of the supplier group:

•      When suppliers sell to a number of industries and a particular industry does not represent a significant fractions of sales, suppliers are much more prone to exert powers. If the industry is an important customer, suppliers fortunes will be tied up to the industry and they will want to protect it through reasonable pricing and assistance in activities like R&D and lobbying.

•      iv) The suppliers’ product is an important input to the buyer’s business:

•      Such an input is important to the success of the buyer’s manufacturing process or product quality. This raises the supplier power. This is particularly true when the input is not storable, thus enabling the buyer to build up stocks of inventory.

•      v) The supplier group’s products are differentiated or it has built up switching costs:

•      Differentiation or switching costs facing the buyers cut off their options to play one supplier against another. If the supplier faces the switching costs the effect is the reverse.

•      vi) The supplier group poses a credible threat of forward integration:

•      This provides a check against the industry’s ability to improve the terms on which it purchases.

THREAT OF SUBSTITUTES:

•       It becomes high when:

•      i) Existing products have a lower price performance ratio than the new product.

•      ii) Number of substitutes are very high

•      iii) Switching costs for the buyers are very low. The point to be noted here, that here we have to take into account the indirect substitutes such as product for product (Fax vs. E-mail), Substitution of needs, Generic substitutes and doing away with the product itself (Tobacco).**