CHAPTER FOUR

ENVIRONMENTAL ANALYSIS

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Situation analysis is concerned with identifying
the position of the firm in respect of the
business environment it operates in and how
well its resources and capabilities meet the
demands of that business environment.
Applying these to one’s own situation can help
in identifying potential opportunities and
threats facing the organization based on its
strengths and weaknesses.
The Figure below illustrates the organization in
the context of various levels of its environment.
1
 General Environment

Economic

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Social
Competitive environment component
component

Product The organization Supplier

component
component

Tariku Jebena
Internal environment

 Organization aspects
 Marketing aspects
 Financial aspects
 Personnel aspects
 Production aspects

Labor Rivalry
component component

Buyer Technological
Political component component
component

Regulatory
component 2

Figure 1: The organization and its

environment
 How does one Analyze the Environment?
Figure below presents a six-step procedure for

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analyzing the external and internal environment
to identify the firm’s strategic position (or
standing):
1. Undertake a general audit of environmental
influences; the aim is to identify which of the
many different sorts of general environmental
factors have influenced the past performance
and development of the organization along with
some consideration as to which will in the future.
2. Consider the nature of the organization’s
environment in terms of how uncertain it is. Is it
(a) static/simple, (b) dynamic or (c) complex?
3
 Conte..

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3. Undertake a structural analysis to identify the key
forces operating in the competitive environment.
4. Analyze the organization’s position relative to its
competitors (either for resources or customers).
5. Consider the internal environment with the aim of
identifying the strengths and weaknesses of the
organization.
6. Relate the strengths and weaknesses of the
organization (based on an internal audit of the
firm’s capabilities ) against the opportunities and
threats thrown up by the analysis of the external
environment. 4
Fig .Situation analysis
Strate
gic
positio
n

Relate SW to OT
Identify strengths and
weaknesses
Identify competitive
position

Identify key environment

forces

Assess the nature of the

environment

Assess the Environment

5 08/22/2025
 Cont…

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The audit requires two related questions to
be addressed:
What factors in the general (wider)
environment are affecting the firm?
Which of these are the most important either
at present or in the future?
Each set of environmental factors should be
considered in turn.
The following list may be useful as a checklist
for identifying key forces:
6
 Conte..

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I. Economic factors:
(a) disposable income, (b) interest rates, (c)
exchange rates, (d) economy growth rates, (e)
unemployment levels, (f) energy and basic raw
material prices.
II. Technological factors:
 (a) new discoveries/developments in own or
related (e.g. supplier) industry, (b) speed of
technology transfer (diffusion), (c) government
spending on research, (d) rates of
obsolescence. 7
 Conte…

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III. Legal factors: (a) employment law, (b) competition
legislation, (c) environmental protection laws, (d)
foreign trade regulations, (e) planning regulations.
IV. Political factors: (a) government stability, (b) taxation
policy, (c) government spending, (d) government
relations with other countries, (e) industrial policy
(e.g. towards privatization and regulation).
V. Social factors: (a) population demographics, (b)
culture (c) levels of education, (d) lifestyle changes, (e)
attitudes to work and leisure, (f) consumerism, (g)
social mobility.
VI. Physical Environment
VII. Global Environment 8
 Economic Forces

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Macroeconomic forces affect the general health and
well-being of a nation or the regional economy of an
organization, which in turn affect companies’ and
industries’ abilities to earn an adequate rate of return.
The four most important macroeconomic forces are the
growth rate of the economy, interest rates,
currency exchange rates, and inflation (or
deflation) rates.
Economic growth, because it leads to an expansion in
customer expenditures, tends to produce a general
easing of competitive pressures within an industry.
This gives companies the opportunity to expand their
operations and earn higher profits. 9
 Technological Forces

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Since World War II, the pace of technological
change has accelerated.
Technological change can make established
products obsolete overnight and simultaneously
create a host of new product possibilities.
Thus, technological change is both creative and
destructive- both an opportunity and a threat.
One of the most important impacts of
technological change is that it can affect the
height of barriers to entry and therefore
radically reshape industry structure. 10
 Social Forces

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Social forces refer to the way in which changing
social traditions and values affect an industry.
Like other macro environmental forces
discussed here, social change creates
opportunities and threats.
One major social movement of recent decades
has been the trend toward greater health
consciousness.
Its impact has been immense, and companies
that recognized the opportunities early have
often reaped significant gains. 11
 Political and Legal Forces

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Political and legal forces are outcomes of
changes in laws and regulations.
They result from political and legal
developments within society and significantly
affect companies.
Essentially, this segment represents how
organizations try to influence governments
and how they try to understand the influences
(current and projected) of those governments
on their strategic actions.
12
The Physical/Natural Environment

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The natural environment includes physical
resources, wildlife, and climate that are an
inherent part of existence on Earth.
The physical environment analysis refers to
assessing the potential and actual changes in
the physical environment and business
practices that are intended to positively
respond to and deal with those changes.
There are many parts or attributes of the
physical environment that firms should consider
as they try to identify trends in this segment. 13
 Step 2: Structural Analysis of the
Competitive Environment

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The second stage in analyzing the environment is
to place all the key influences and their degree of
relevance within a framework of analysis which
provides a structure to gauge the nature and
intensity of competition.
Industry competitive analysis begins by focusing
on the overall industry in which a firm competes
before market segments or sector-level issues are
considered.
Tools that managers can use to perform such
industry analysis are discussed in the following
sections: Porter’s five forces model, strategic
group analysis, and industry life cycle analysis. 14
 I Porter’s Five Forces Model
Porter’s framework is essentially a structured means of

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examining the competitive environment of an
organization so as to provide a clear understanding of
the forces at work.
As used by the model, competition does not mean just
product (or resource) competition only, rather it is the
broader notion of ‘competition for profits’.
The framework is based on the view that forces facing
the industry play a key role in determining the
profitability and success of an organization.
Porter argues that the intensity of competition is rooted
in its underlying structure.
Understanding the industry structure and how the
forces operate can aid to improve performance if the
organization can take action to avoid them or influence 15

them.
 Potential entrants

Threat of new
entrants

Industry
competitors
Bargaining power Bargaining power
of buyers of suppliers
Buyers Suppliers

Rivalry among
existing firms

Threat of substitute
products or services

Substitutes

16 forces model of
Figure 2: The five 08/22/2025
 Conte..

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There are five key forces to be considered in
industry analysis:
1. Entry barriers. How easy is it for a
new firm to enter the industry?
 New entry into the industry invariably reduces the
existing firms’ profitability.
Therefore, existing firms should be concerned with
how easy it is to entry the industry.
High entry barriers are generally required to
maintain high industry profits.
When possible, firms should seek to prevent (deter)
new entry. 17
 2 . C o m p e t i t i v e r i v a l r y.
The second of Porter’s five competitive

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forces is the intensity of rivalry among
established companies within an industry.
Rivalry refers to the competitive struggle
between companies in an industry to gain
market share from each other.
The competitive struggle can be fought using
price, product design, advertising and
promotional spending, direct selling efforts,
and after-sales service and support.
More intense rivalry implies lower prices or
more spending on non–price-competitive
weapons, or both. 18
 3. Substitute products
Substitute products are the products of

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different businesses or industries that can
satisfy similar customer needs.
The existence of close substitutes is a strong
competitive threat because this limits the price
that companies in one industry can charge for
their product, and thus industry profitability.
Pressure on an industry will be stronger the
more close substitutes (i.e. demand related
products) there are.
In considering their influence, the strategist
needs to examine substitutes on their price–
performance, their mark-ups and costs of19
production.
 4 Power of Buyers
An industry’s buyers may be the individual

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customers who ultimately consume its products
(its end users) or the companies that distribute
an industry’s products to end users, such as
retailers and wholesalers.
The bargaining power of buyers refers to the
ability of buyers to bargain down prices charged
by companies in the industry or to raise the
costs of companies in the industry by demanding
better product quality and service.
By lowering prices and raising costs, powerful
buyers can squeeze profits out of an industry.
Thus, powerful buyers should be viewed as a20
threat.
 5 Power of Suppliers
 Suppliers are the organizations that provide inputs

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into the industry, such as materials, services, and
labor (which may be individuals, organizations such as
labor unions, or companies that supply contract labor).
 The bargaining power of suppliers refers to the ability
of suppliers to raise input prices, or to raise the costs
of the industry in other ways, for example, by
providing poor-quality inputs or poor service.
 Powerful suppliers squeeze profits out of an industry
by raising the costs of companies in the industry.
 Thus, powerful suppliers are a threat.
 Alternatively, if suppliers are weak, companies in the
industry have the opportunity to force down input
prices and demand higher quality inputs (such as
more productive labor). 21
 II. The Industry life-cycle model

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This represents a relatively simple way of
conceiving the firm’s position in terms of the
stage of development of its markets (i.e. their
position in the life cycle of such markets).
The model is based on the view that
conditions in the market place, in terms of
growth and maturity of markets,
fundamentally affect market conditions and
competitive behaviour.
Generally, different strategies are required at
different stages in the life cycle to cope with
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the different competitive conditions.
 Conte..

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An important determinant of the strength of
the competitive forces in an industry (and thus
of the nature of opportunities and threats) is
the changes that take place in it over time.
The similarities and differences between
companies in an industry often become more
pronounced over time, and its strategic group
structure frequently changes.
The strength and nature of each of the
competitive forces also change as an industry
evolves, particularly the two forces of risk of
entry by potential competitors and rivalry
23
among existing firms.
 Conte..
A useful tool for analyzing the effects of

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industry evolution on competitive forces is
the industry life cycle model, which identifies
five sequential stages in the evolution of an
industry that lead to five distinct kinds of
industry environment: embryonic, growth,
shakeout, mature, and decline.
The task facing managers is to anticipate how
the strength of competitive forces will change
as the industry environment evolves and
formulate strategies that take advantage of
opportunities as they arise and that counter
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emerging threats.
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25
Conte..
 1. Embryonic Industries

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An embryonic industry is just beginning to
develop (e.g., personal computers and
biotechnology in the 1970s, wireless

Tariku Jebena
communications in the 1980s, Internet
retailing in the early 1990s, and
nanotechnology today).
Growth at this stage is slow because of such
factors as buyers’ unfamiliarity with the
industry’s product, high prices due to the
inability of companies to reap any
significant economies of scale, and poorly
developed distribution channels 26
 Cont…

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Barriers to entry tend to be based on access to key
technological know-how rather than cost economies
or brand loyalty.
If the core know-how required to compete in the
industry is complex and difficult to grasp, barriers to
entry can be quite high, and established companies
will be protected from potential competitors.
Rivalry in embryonic industries is based not so much
on price as on educating customers, opening up
distribution channels, and perfecting the design of
the product. Such rivalry can be intense; the
company that is the first to solve design problems
often has the opportunity to develop a significant
27
market position.
 2. Growth Industries

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Once demand for the industry’s product begins to
take off, the industry develops the characteristics of
a growth industry.
In a growth industry, first-time demand is
expanding rapidly as many new customers enter
the market.
Typically, an industry grows when customers
become familiar with the product; prices fall
because experience and economies of scale have
been attained, and distribution channels develop.
Normally, the importance of control over
technological knowledge as a barrier to entry has
diminished by the time an industry enters its
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growth stage.
 3. Industry Shakeout
Explosive growth cannot be maintained

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indefinitely. Sooner or later, the rate of growth
slows, and the industry enters the shakeout
stage.
In the shakeout stage, demand approaches
saturation levels; most of the demand is
limited to replacement and there are few
potential first-time buyers left.
As an industry enters the shakeout stage,
rivalry between companies becomes intense.
Typically, companies that have become
accustomed to rapid growth continue to add
29
capacity at rates consistent with past growth.
 4. Mature Industries
The shakeout stage ends when the industry

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enters its mature stage: the market is totally
saturated, demand is limited to replacement
demand, and growth is low or zero.

Tariku Jebena
Perhaps growth, if any, comes from population
expansion that brings new customers into the
market or an increase in replacement demand.
As an industry enters maturity, barriers to entry
increase, and the threat of entry from potential
competitors decreases.
As growth slows during the shakeout,
companies can no longer maintain historic
growth rates merely by holding on to their 30

market share.
 5. Declining Industries
Eventually, most industries enter a decline

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stage: growth becomes negative for a variety of
reasons, including :
technological substitution (e.g., air travel for

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rail travel);
social changes (e.g., greater health
consciousness hitting tobacco sales);
demographics (e.g., the declining birthrate
hurting the market for baby and child
products); and
international competition (e.g., low-cost
Chinese footwear competition pushed the Eth 31
footwear industry into decline).
 Step 3 The Internal Environment
Analysis
Having gained an understanding of the external

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environment facing the firm, the next stage is
to assess the firm’s resources with the intention
of identifying its strategic capability based on
understanding its strengths and weaknesses.
Sometimes called organizational
analysis/corporate appraisal/audit of
organizational competences and resources,
internal environmental analysis is the process
through which strategists and managers
analyze the various factors of their organization
to evaluate their relative strengths and
weaknesses so as to meet the opportunities and 32
threats of the external environment.
 Process of Organizational Analysis
Development of a company profile involves a

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four step process that a strategist should find
useful in guiding internal analysis.
It also conveniently summarizes all processes
that are involved in internal analysis.
In step 1, managers audit and examine key
aspects of the business’s operations, seeking
to target key areas for further assessment.
Areas targeted are those deemed central to
the firm’s strategic direction. As such, they
are called “strategic internal factors”.
33
 Conte..
Step 2 has managers evaluating the firm’s

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status on these factors by comparing their
current condition with past abilities of the
firm. This is where most managers start their
planning efforts.
How do we compare with last year?
Have we improved over last year?
Are we better able to do key things than we
were last year?
Does each key factor represent a favorable or
an unfavorable situation?
34
 Conte..
The third step is very critical. Managers seek

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some comparative basis-linked to key industry
or market/product conditions-against which to
more accurately determine whether the
company’s condition on a particular factor
represent a potential strength or weakness.
Mangers use different perspectives to do this:
for example: 1)requirements for success across
different product/market stages of evolution, 2)
what competitors are capable of
doing3)perceived key requirements for success
in the market/industry segments in which they
compete, and 4)the VRIO approach. 35
 Conte..

The result of the third step should be a

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determination of whether key strategic
internal factors are:
a) Competitive advantage-factors providing
the company with an edge compared to its
competitors, and therefore key factors
around which to build the firm’s strategy.
b) Basic business requirements-factors
that are important capabilities for the firm
to have but are also typical of every viable
competitors; does not represent a potential
source of any strategic advantage. 36
 Conte…

c) Key vulnerabilities-factors on which the

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company currently lacks the necessary skill,
knowledge, or resources to compete effectively.
This assessment is also a key input into the
strategic management process because
managers will want to avoid choosing strategies
that depend on factors in this category. And
managers usually target key vulnerabilities as
areas for special attention so as to remediate and
change this situation.
The final step in internal analysis is to provide
the results, or company profile, as input into the
strategic management process. This input is vital
during the early, strategy formulation phase in the
strategic management process. 37
 Identification of strategic internal
factors and value activities

How do these factors and activities compare with

historical information and internal standards of
excellence?
Favorable/probable
Unfavorable/
Strength apparent
weakness

How do these strengths and weaknesses compare with key

concerns at relevant stages of product/market evolution?

How do these strengths and weaknesses compare with the

capabilities and resources associated with key competitors?

How do these strengths and weaknesses compare with key

requirements of success in the industry/market sectors
being considered?

Provides an edge Necessary skill but

Necessary skill not present

Input for Strategy Analysis and

38
Choice 08/22/2025
 Conte..

While this figure explains internal analysis as a

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process, it is important to remember that each
step in the process often overlaps another step.
Thus separating each step helps explain the
process of internal analysis; but, in practice,
efforts to distinguish each step are seldom
emphasized because the process is very
interactive.
When the internal analysis is accurate,
thorough, and timely, managers are in a better
position to formulate effective strategies.
39