Module 3
Lesson 3 Analyzing a Company’s External Environment
Analyzing a company’s external environment means examining the outside factors that can
impact the business. These include economic, political, technological, legal, competitive, and
social factors that are beyond the control of the company but influence its success or failure.
To identify opportunities (favorable external trends/factors) and to spot threats (external risks
and challenges). To make informed strategic decisions to be able to stay competitive and
adaptive.
Importance:
Helps businesses anticipate changes and prepare for them
Allows companies to align strategies with the external environment
Encourages innovation and flexibility
Improves risk management
1. Nature of an External Assessment
An external assessment is a continuous process of collecting, analyzing, and using information
about external factors to help guide strategic planning. It focuses on forces the business cannot
control, but can respond to.
Examples:
1. A coffee shop analyzes market trends showing increasing demand for plant-based milk
options and decides to offer soy and almond milk.
2. A tech company monitors competitors’ innovation trends and adjusts its product
development accordingly.
2. The Industrial Organization (I/O) View
This theory suggests that external factors (industry structure, competition, economic
conditions) have a stronger effect on company performance than internal factors like staff skills
or management styles.
Examples:
1. A retail business in a highly competitive market with low entry barriers must lower
prices to survive, regardless of its internal strengths.
2. A company in a monopolistic industry (like public utilities) thrives due to lack of
competition, even with average internal operations.
Monopolistic industry single company dominates the market and has significant control over the supply
and price of a product or service.
3. Political, Governmental, and Legal Forces
These include government regulations, political stability, trade policies, labor laws, and other
legal constraints that influence business operations.
Examples:
1. A new law requiring plastic-free packaging forces a food manufacturer to redesign its
packaging system.
2. A change in tax rates affects the profitability of small businesses, pushing them to adjust
pricing strategies.
4. Technological Forces
Technology can create both opportunities (through innovation) and threats (through
obsolescence). Businesses must adapt to tech changes in production, communication, and
services.
Examples:
1. A logistics company adopts GPS tracking to improve delivery accuracy and customer
service.
2. A local bookstore faces declining sales as e-books and online retailers become more
popular.
5. Competitive Forces
This refers to the strength and nature of competition within an industry, including pricing,
marketing strategies, and product innovation.
Examples:
1. A fast-food chain lowers prices after a new competitor opens in the same area.
2. A clothing brand increases its marketing efforts to compete with a popular online
fashion retailer.
6. Competitive Analysis: Porter’s Five Forces Model
Porter’s Five Forces help businesses understand the competitiveness in an industry:
Rivalry among competitors this force refers to the intensity of competition among current
companies in the same industry. High rivalry usually leads to price wars, aggressive marketing,
and innovation, which can lower profits for all firms.
Key indicators of strong rivalry:
Many competitors
Slow industry growth
Similar products/services
Rivalry: Pepsi and Coca-Cola constantly compete in pricing, promotions, and product
innovation.
Threat of new entrants This force looks at how easily new businesses can enter the industry
and become competitors. If it’s easy to enter, the threat is high, and existing companies must
work harder to keep their market share.
Barriers to entry may include:
High startup costs
Strong brand loyalty of existing firms
Government regulations
Threat of new entrants: A small coffee shop must defend against new cafes opening
nearby.
Threat of substitutes this force measures how much power customers have to influence prices
and terms. When buyers have many choices or buy in large volumes, they can demand lower
prices or higher quality.
Buyers have high power when:
Products are not unique
They can easily switch to another supplier
They buy in bulk
Substitutes: Ride-hailing apps like Grab compete with traditional taxis.
Bargaining power of buyers This refers to the influence suppliers have over the price and
availability of materials or services. If few suppliers exist or if their product is essential, they can
demand higher prices.
Suppliers have high power when:
There are few substitutes
They supply critical inputs
Switching suppliers is costly
Buyer power: In the airline industry, customers can easily compare prices and choose
the cheapest fare.
Bargaining power of suppliers this force analyzes the risk that customers will switch to
different products that meet the same need. If many substitutes exist, companies may lose
customers easily, especially if alternatives are cheaper or better.
Substitute threats are high when:
Alternatives offer better price or performance
Switching is easy and low-cost
Supplier power: A smartphone manufacturer relying on a single chip supplier may face
high prices or delays if the supplier controls the market.
7. Sources of External Information
Businesses gather information from multiple sources to analyze the environment effectively:
Examples:
1. A business uses government reports and economic forecasts to predict inflation and
consumer behavior.
2. A marketing team studies social media trends and online reviews to understand
consumer preferences and improve product offerings.
Conclusion:
Analyzing a company’s external environment is crucial for survival and growth. It allows firms to
adapt to changes, prepare for threats, and take advantage of opportunities. By understanding
external forces, businesses become more strategic, responsive, and resilient in a rapidly
changing world.
