Theoretical course 2
- 1. INTERNATIONAL BUSINESS STRATEGIES - ENSEC THEORETICAL COURSE N°2: EXTERNAL DIAGNOSIS : THE TOOLS I. Strategy To achieve an objective, managers must develop a suitable strategy. A strategy is a long term plan setting out how an objective will be reached. 1 For example, if the objective is to reduce costs, the strategy could involve relocating or reducing the labour force. If the objective is to boost revenue, the strategy may be to launch new products or to invest in a big promotional campaign. A strategy will usually: • Involve relatively large sums of money • Be relatively difficult to reverse. Once you have started to pursue a particular strategy it may not be easy switch resources in another direction • Be relatively high risk. If you get the strategy wrong this could be costly in many ways for the business • Set out the markets the firm wants to compete in, the products it wants to offer and how it wants to compete (for example, by focusing on low cost or by differentiating its offering) There are different methods of analysing strategies: Ansoff Matrix, Swot analysis, Porter’s 5 forces and Pestel analysis.
- 2. INTERNATIONAL BUSINESS STRATEGIES - ENSEC II. Ansoff Matrix To portray alternative corporate growth strategies, Igor Ansoff presented a matrix that focused on the firm's present and potential products and markets (customers). By considering ways to grow via existing products and new products, and in existing markets and new markets, there are four possible product-market combinations. Ansoff's matrix is shown below: Ansoff’s Matrix Existing Products New Products 2 Existing Markets Market Penetration Product Development New Markets Market Development Diversification Ansoff's matrix provides four different growth strategies: • Market Penetration - the firm seeks to achieve growth with existing products in their current market segments, aiming to increase its market share. • Market Development - the firm seeks growth by targeting its existing products to new market segments. • Product Development - the firms develops new products targeted to its existing market segments. • Diversification - the firm grows by diversifying into new businesses by developing new products for new markets.
- 3. INTERNATIONAL BUSINESS STRATEGIES - ENSEC Selecting a Product-Market Growth Strategy The market penetration strategy is the least risky since it leverages many of the firm's existing resources and capabilities. In a growing market, simply maintaining market share will result in growth, and there may exist opportunities to increase market share if competitors reach capacity limits. However, market penetration has limits, and once the market approaches saturation another strategy must be pursued if the firm is to continue to grow. Market development options include the pursuit of additional market segments or geographical regions. The development of new markets for the product may be a good strategy if the firm's core competencies are related more to the specific product than to its 3 experience with a specific market segment. Because the firm is expanding into a new market, a market development strategy typically has more risk than a market penetration strategy. A product development strategy may be appropriate if the firm's strengths are related to its specific customers rather than to the specific product itself. In this situation, it can leverage its strengths by developing a new product targeted to its existing customers. Similar to the case of new market development, new product development carries more risk than simply attempting to increase market share. Diversification is the most risky of the four growth strategies since it requires both product and market development and may be outside the core competencies of the firm. In fact, this quadrant of the matrix has been referred to by some as the "suicide cell". However, diversification may be a reasonable choice if the high risk is compensated by the chance of a high rate of return. Other advantages of diversification include the potential to gain a foothold in an attractive industry and the reduction of overall business portfolio risk.
- 4. INTERNATIONAL BUSINESS STRATEGIES - ENSEC III. Developing a strategy: SWOT analysis In an earlier part of this section we outlined what was meant by a strategy. We now consider how a strategy may be formed. To determine what their strategy should be managers must consider the internal strengths and weaknesses of their organisation and compare these with the external opportunities and threats. This process is known as SWOT analysis. Strengths are internal factors that a firm may build on to develop a strategy. For example, they may include: • Marketing strengths, for example a strong brand or access to a good distribution 4 network • Financial strengths, for example a high level of cash, access to loan capital if needed and a good credit rating • Operations strengths, for example a high level of efficiency, flexible production systems and high quality levels • Human Resources Management (HRM) strengths, for example a well trained workforce, a creative and motivated workforce and good employer-employee relations Weaknesses are internal factors that a firm may need to protect itself against such as: • Marketing weaknesses such as limited distribution, a poor product range and ineffective promotion • Financial weaknesses such as high levels of borrowing and low rates of return • Operational weaknesses such as old, inefficient equipment and poor quality • HRM weaknesses such as a high rate of labour turnover and industrial disputes Managers must identify the specific strengths and weaknesses of their business and rate these according to how significant they are. They should then compare these with the external opportunities and threats identified by PESTEL analysis.
- 5. INTERNATIONAL BUSINESS STRATEGIES - ENSEC This is SWOT analysis. 5 A strategy may be developed by using a firm's strengths to exploit the opportunities that exist. For example, a strong brand name may be used to extend a firm's products into new markets. It may also use these strengths to protect itself against threats; for example, a retailer may use its finance to acquire key locations to prevent a competitor buying them. A firm may also want to protect itself against its weaknesses. For example, it may try to find alternative suppliers to reduce an over-reliance on a particular one; it may invest in a rebranding exercise to reposition itself. Undertaking a SWOT analysis effectively is not as easy as it may seem. First managers have to correctly identify what all the relevant factors are and how important each one is. Secondly, managers need to work out the most appropriate strategy that combines the strengths and opportunities and actually implement the plan successfully. It is also important to undertake this type of analysis regularly because the competitive landscape and the internal situation will be constantly changing. The importance of strategy should not be underestimated. Changing the price of an item, changing the distribution strategy and investing in new equipment are all important decisions but if you are fighting in the wrong market with the wrong products then the details are almost irrelevant. This involves an understanding not only of what happens within the firm but also the ability to forecast changes in the external environment and their significance successfully
- 6. INTERNATIONAL BUSINESS STRATEGIES - ENSEC IV. PESTEL analysis of the macro-environment There are many factors in the macro-environment that will effect the decisions of the managers of any organisation. Tax changes, new laws, trade barriers, demographic change and government policy changes are all examples of macro change. To help analyse these factors managers can categorise them using the PESTEL model. This classification distinguishes between: • Political factors. These refer to government policy such as the degree of intervention in the economy. What goods and services does a government want to provide? To what extent does it believe in subsidising firms? What are its priorities in terms of 6 business support? Political decisions can impact on many vital areas for business such as the education of the workforce, the health of the nation and the quality of the infrastructure of the economy such as the road and rail system. • Economic factors. These include interest rates, taxation changes, economic growth, inflation and exchange rates. An economic change can have a major impact on a firm's behaviour. For example: - higher interest rates may deter investment because it costs more to borrow - a strong currency may make exporting more difficult because it may raise the price in terms of foreign currency - inflation may provoke higher wage demands from employees and raise costs - higher national income growth may boost demand for a firm's products • Social factors: Changes in social trends can impact on the demand for a firm's products and the availability and willingness of individuals to work. • Technological factors: new technologies create new products and new processes. MP3 players, computer games, online gambling and high definition TVs are all new markets created by technological advances. Technology can reduce costs, improve quality and lead to innovation. These developments can benefit consumers as well as the organisations providing the products. • Environmental factors: environmental factors include the weather and climate change. Changes in temperature can impact on many industries including farming, tourism and insurance. The growing desire to protect the environment is having an impact on many industries such as the travel and transportation industries and the general move towards more environmentally friendly products and processes is affecting demand patterns and creating business opportunities. • Legal factors: these are related to the legal environment in which firms operate. The introduction of age discrimination and disability discrimination legislation, an increase in the minimum wage and greater requirements for firms to recycle are examples of relatively recent laws that affect an organisation's actions. Different categories of law include:
- 7. INTERNATIONAL BUSINESS STRATEGIES - ENSEC • consumer laws; these are designed to protect customers against unfair practices such as misleading descriptions of the product • competition laws; these are aimed at protecting small firms against bullying by larger firms and ensuring customers are not exploited by firms with monopoly power • employment laws; these cover areas such as redundancy, dismissal, working hours and minimum wages. They aim to protect employees against the abuse of power by managers • health and safety legislation; they cover issues such as training, reporting accidents and the appropriate provision of safety equipment By using the PESTEL framework we can analyse the many different factors in a firm's macro environment 7 It is also important when using PESTEL analysis to consider the level at which it is applied. When analysing companies such as Sony, Chrysler, Coca Cola, BP and Disney it is important to remember that they have many different parts to their overall business - they include many different divisions and in some cases many different brands. Whilst it may be useful to consider the whole business when using PESTEL in that it may highlight some important factors, managers may also want to differentiate between factors which are very local, other which are national and those which are global. This version of PESTEL analysis is called Long PESTEL. This is illustrated below: LOCAL NATIONAL GLOBAL POLITICAL Provision of services UK government policy World trade by local council on subsidies agreements for example further expansion of the EU ECONOMIC Local income UK interest rates Overseas economic growth SOCIAL Local population Demographic change Migration flows growth (for example ageing population) TECHNOLOGICAL Improvements in local UK wide technology International technologies for for example UK online technological example availability of services breakthroughs for Digital TV example internet ENVIRONMENTAL Local waste issues UK weather Global climate change LEGAL Local UK law International licences/planning agreements on human permission rights or environmental policy
- 8. INTERNATIONAL BUSINESS STRATEGIES - ENSEC V. Porter's Five Forces analysis of market structure The competitive structure of an industry can be analysed using Porter's five forces. This model attempts to analyse the attractiveness of an industry by considering five forces within a market. According to Porter (1980) the likelihood of firms making profits in a given industry depends on five factors: 1. The likelihood of new entry = the extent to which barriers to entry exist. The more 8 difficult it is for other firms to enter a market the more likely it is that existing firms can make relatively high profits. The likelihood of entering a market would be lower if: • the entry costs are high for example if heavy investment is required in marketing or equipment • there are major advantages to firms that have been operating in the industry already in terms of their experience and understanding of how the market works (this is known as the "learning effect") • Government policy prevents entry or makes it more difficult; for example, protectionist measures may mean a tax is placed on foreign products or there is a limit to the number of overseas goods that can be sold. This would make it difficult for a foreign firm to enter a market • the existing brands have a high level of loyalty • the existing firms may react aggressively to any new entrant for example with a price war • the existing firms have control of the supplies .e.g. entering the diamond industry might be difficult because the majority of known sources of diamonds are controlled by companies such as De Beers. 2. The power of buyers. The stronger the power of buyers in an industry the more likely it is that they will be able to force down prices and reduce the profits of firms that provide the product. Buyer power will be higher if: • there are a few, big buyers so each one is very important to the firm • the buyers can easily switch to other providers so the provider needs to provide a high quality service at a good price • the buyers are in position to take over the firm. If they have the resources to buy the provider this threat can lead to a better service because they have real negotiating power
- 9. INTERNATIONAL BUSINESS STRATEGIES - ENSEC 3. The power of suppliers. The stronger the power of suppliers in an industry the more difficult it is for firms within that sector to make a profit because suppliers can determine the terms and conditions on which business is conducted. Suppliers will be more powerful if: • there are relatively few of them (so the buyer has few alternatives) • switching to another supplier is difficult and/or expensive • the supplier can threaten to buy the existing firms so is in a strong negotiating position 9 4. The degree of rivalry This measures the degree of competition between existing firms. The higher the degree of rivalry the more difficult it is for existing firms to generate high profits. Rivalry will be higher if: • there are a large number of similar sized firms (rather than a few dominant firms) all competing with each other for customers • the costs of leaving the industry are high for example because of high levels of investment. This means that existing firms will fight hard to survive because they cannot easily transfer their resources elsewhere • the level of capacity utilisation. If there are high levels of capacity being underutilised the existing firms will be very competitive to try and win sales to boost their own demand • the market is shrinking so firms are fighting for their share of falling sales • there is little brand loyalty so customer are likely to switch easily between products 5. The substitute threat. This measures the ease with which buyers can switch to another product that does the same thing for example aluminium cans rather than glass or plastic bottles. The ease of switching depends on what costs would be involved (for example transferring all your data to a new database system and retraining staff could be expensive) and how similar customers perceive the alternatives to be. Using Porter's analysis firms are likely to generate higher returns if the industry: • Is difficult to enter • There is limited rivalry • Buyers are relatively weak • Suppliers are relatively weak • There are few substitutes.
- 10. INTERNATIONAL BUSINESS STRATEGIES - ENSEC On the other hands returns are likely to be low if: • The industry is easy to enter • There is a high degree of rivalry between firms within the industry • Buyers are strong • Suppliers are strong • It is easy to switch to alternatives The implication of Porter's analysis for managers is that they should examine these five factors before choosing an industry to move into. 10