Strategy development from the perspective of external pressures (both positive and negative) in the business environment.

Aims and Objectives

This Learning Object aims to examine strategy development from the perspective of external pressures (both positive and negative) in the business environment. In the following learning object we will examine strategy development from the perspective of an organisation’s internal environment, including its resources, capabilities, and competencies. The objective here is to provide you with the opportunity to appreciate the influence of industry structure and the macro environment on strategy, and to appreciate some of the debates regarding the sources of value and competitive advantage.

Key Concepts, Constructs and Debates

1.Analysis of the external and internal environment

De Wit and Meyer (2010) contrast the external and internal views of strategy making for competitive advantage as ‘outside-in’ versus ‘inside-out’ perspectives. Companies with ‘outside-in’ perspectives take their cues from the markets, i.e. customers and competitors and organise their resources accordingly. These market driven companies ensure they have insight into the structure of markets, the needs of industries and the specific demands, strengths, positions and intentions of all the major external forces on the business environment. Companies with ‘inside-out’ perspectives build around a company’s strengths looking to refine and acquire difficult-to-imitate competencies and exclusive assets, and emphasising competitive advantage available from intangible resources. We will concentrate our analysis on the ‘outside-in’ perspective this week, although inevitably, we must also address the contrasting perspectives, and will do so as appropriate.

Hill and Jones (2010) examine a range of the ‘external’ industry based and macro-environmental issues to be considered in strategy making. They utilise an ‘opportunities and threats’ perspective (being the ‘OT’ part of a ‘SWOT’ type analysis) and you are encouraged to critique this approach as you undertake the reading and exercises. This approach is consistent with the premises of a rational decision making model in which some form of ‘gap’ is identified between what exists and what appears possible (for either gain or loss), with potential actions then being developed that are expected to close the gap. Whilst this methodology might appear to be a useful way of conceptualising some issues, in highly complex and dynamically shifting environments, there may be problems in assuming linear and predictable relationships between ’cause and effect’ or ‘stimulus and response’.

Consider also the earlier literature on the influence of biases, the influence of individual cognitive processing and perception, the possibility of incomplete information being available, and the potential for decisions needing to be made based on probabilities, not only in relation to outcomes (as is often the case in scenario planning approaches), but also in relation to the quality of information available. For instance, when assessing the risks to business associated with potential climate change impacts there are few concrete facts and a range of potential risks with varying levels of probability – see for instance the Garnaut Climate Change Review http://www.garnautreview.org.au/

Nevertheless, tools are needed to conceptualise both external pressures for change and the potential ranges of strategic responses, just as tools are needed to help guard against perceptual errors, biases or relying on false assumptions.

2.External analysis

Exercise: Read Chapter Two of Hill and Jones (2010) “External analysis: the identification of opportunities and threats” before continuing

This chapter defines what constitutes an ‘industry’ and explains a model (Porter’s five forces – Porter 1980) that has been used extensively to analyse industry structure and an organisation’s opportunities for gaining competitive advantage within that industry; including discussion on the threat of new entrants, rivalry amongst established companies in the industry, the threat of substitutes and the bargaining power of both suppliers and buyers. It also discuss what they call a sixth force, i.e. the power, vigour and competence of complementors or companies that sell products or services that complement an organisation’s own product offerings. It is suggested that strategy is developed to leverage from the opportunities and strengths and to counter the threats and weaknesses a business may exhibit in some or all of these areas in relation to industry competitors.

Note that Porter (2008) has revisited the ‘five forces’ model and addressed recent arguments about ‘complementors’, referring to these (and some other influences) as ‘factors’ that need to be taken into account in evaluating the external industry environment.

At a practical level, resources exist to assist with industry analysis, such as Industry Associations (such as Australian Industry Group at http://www.aigroup.asn.au/ ), Government departments (such as Business Victoria at http://www.business.vic.gov.au/BUSVIC/HOMEPAGE// , The Productivity Commission at http://www.pc.gov.au/ , AusIndustry at http://www.ausindustry.gov.au/ ) and Industry research specialists (such as IBISWorld at http://www.ibisworld.com.au/ ). Swinburne Library has put together an Industry Research resource that includes many appropriate links (http://www.swinburne.edu.au/lib/subjectguide/ausind.htm#gov ). Note particularly that the structure of the reports from industry research companies usually directly address many of the elements affecting industry competitiveness as well as some pertinent macroeconomic factors. Also note that note that some IBIS reports can be accessed through Swinburne Library, and that Business Victoria provides viewable (but not printable) access from its premises.

Hill and Jones (2010) also discuss of a range of other factors to be taken into account in a broad ranging external analysis and assessment of ‘industry’ impacts, including macroeconomic forces, the limitations of narrow industry structure focus, the role of strategic groups and mobility barriers, industry lifecycle, differences in company structures, global forces, technological forces, social forces, political and legal forces. Issues associated with ‘technological forces’ are further expanded in Chapter Seven “Strategy and Technology”, and it is interesting to note that there is no further elaboration in the text on ‘social forces’, such as those discussed earlier in relation to, for instance;

a corporation’s social responsibilities to reduce its harmful externalities (i.e. spill-over effects of its activities to parties not directly benefiting from those activities), or

associated community pressures on business to

reduce non-renewable resource usage,

assist in the development of new energy sources,

develop collaborative cross-sector alliances to help develop new markets in developing countries (sometimes called ‘business at the bottom of the pyramid’), or

develop more sustainable business practices that integrate the simultaneous achievement of economic, social and environmental goals within its core value offerings.

As noted earlier, Porter and Kramer (2011) advocate that organisations that focus on creating shared value for business and for society simultaneously will achieve competitive advantage, by recognising “that societal needs, not just conventional economic needs, define markets” (p. 65).

Also, as noted earlier, an assessment of an organisation’s stakeholders and the impact of the businesses goals and activities on them would appear to be foundational information to undertake a holistic assessment of the ‘external’ risks to the business, both for opening / closing markets and for broader contextual influences on business continuance.

It would therefore seem that any strategic analysis that does not recognise broad social pressures for change may risk being a partial assessment of the external environment.

3.A further perspective on industry development

De Wit and Meyer (2010) reinforce the above perspectives and outline several key aspects of industry development that an external analysis might consider:

The changing rules of competition within the industry – where the rules that arise from the structure of the industry change as a result of shifts in industry structure and aspects of competitive interaction(as discussed earlier using Porter’s five forces analysis)

The nature and direction of changes – where the pace and type of changes will influence the response of managers

The determinants of industry changes – where drivers push an industry in certain directions and inhibitors act as a brake on changes.

This is represented as follows:

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Figure: Industry development facets (adapted from De Wit and Meyer 2010)

4.The changing rules of competition within an industry

As noted above, Porter’s (1979, 1980) five forces model identifies five important groups of industry actors (competitors, buyers, suppliers, new entrants and substitutes) and the underlying factors that influence their behaviour and responses by others. At an industry level of analysis, industries can develop as a result in changes to the underlying factors.

According to De Wit and Meyer (2010) significant industry developments may also take place along one of several dimensions:

Convergence-divergence – where the business models of industry players move towards similarity the industry is converging (e.g. airlines, insurance companies). Where new business models are being introduced, the industry in moving towards diversity (e.g. prepared food). Convergence results from less successful firms adopting the dominant business model or being eliminated through failure to adapt. Divergence can result from the ‘mutation’ of firms seeking to develop distinct and different competitive positions or from the successes of new entrants.

Concentration-fragmentation – where an increasing share of the market is in the hands of a few companies (e.g. media), the industry is concentrated. Where the largest players are losing market share the industry is fragmenting (e.g. airlines and telecom services). Concentration can be due to mergers and acquisitions or the exit of companies from the industry. Fragmentation can be due to existing companies entering new industries or significant new entrants.

Vertical integration-fragmentation – where firms are becoming involved in more value-adding activities in the ‘industry column’ or in activities that their suppliers (upstream) or buyers (downstream) might have been previously involved in it is said to be more vertically integrated (e.g. media and IT). Conversely where firms are divesting themselves of activities that are not central to their ‘core’, the industry is said to be moving towards a more disintegrated, layered or vertically fragmented structure (e.g. telecom and automotive industries).

Horizontal integration-fragmentation – where boundaries between different industries become increasingly blurred the industry can be regarded as becoming horizontally integrated (e.g. consumer electronics). A more segmented or horizontally fragmented structure describes the opposite, i.e. clear boundaries and firms confined to their own business (e.g. construction). Note that inter-industry integration can create more open competitive space (Hamel and Prahalad 1994) with few mobility barriers; as we are witnessing with industries based on digital technology.

International integration-fragmentation – where international boundaries are becoming less important, the industry is said to be developing a more internationally integrated structure (e.g. business education). Where local conditions confine competitive interactions to a region, the industry is said to be internationally fragmented.

Expansion-contraction – industries can also differ based on demand for their products and services. A long period of increase in demand is termed growth or expansion and a long period of decreasing demand is termed decline or contraction.

5.The drivers and inhibitors of change in industry development

De Wit and Meyer (2010) suggest there are “an endless list of factors in the environment that can change and influence the direction of industry development” (p. 186).

They suggest the change drivers in the ‘contextual environment’ (that is the environment relevant for conducting business activity in the industry) can be conceived as

Socio cultural – e.g. changing health needs, environmental pressures, consumption habits

Economic – e.g. changing exchange rates, economic growth, labour productivity

Political regulatory – e.g. new trade regulations, environmental protection laws, privatisation initiatives

Technological – e.g. new scientific breakthroughs, innovative technologies, communication standards

… and there are many and complex interactions between these change drivers.

Where significant changes in an industry can be triggered by one firm, the firm could claim industry leadership. However, where change evolves in the industry due to industry dynamics, there can be no industry leader. This has important implications regarding the ability of firms to shape industry development in their favour.

De Wit and Meyer (2010) also list a number of industry conditions that may influence the level of industry ‘rigidity’ and thus act as inhibitors of change. At high levels of industry rigidity, the industry ‘rules of the game’ are difficult to break or bend, making competitive positions relatively fixed. Industry development is therefore inhibited. These inhibitors of industry development are:

Underlying conditions – For instance in some industries economies of scale are essential, (e.g. aircraft manufacture, merchant shipping) and not in others (e.g. dentistry). In some industries buyers are highly concentrated (e.g. defence systems, harbour construction) while in others they are fragmented (e.g. moving services, car repair). These and other industry conditions, e.g. the value of product differentiation versus low cost seem inherent to the industry and defy changes.

Industry integration – some industries have complex linkages between various aspects of the industry that tend to make them rigid and unreceptive to change. The music industry exhibits these features, forcing new entrants to deal with a complex environment of copyright, distribution, electronic media, recording systems, consumer electronics developments, consumer preferences, etc.

Power structures – Industry incumbents with established positions and considerable investments often have much to lose and little to gain from changes to the existing ‘rules of the game’. They can use their powerful positions to inhibit industry development. A prominent historical example would be the activities of cigarette companies to counter the evidence of links to cancer, and more recently the activities of some fossil fuel resource companies to discredit evidence of the damaging effects of carbon emissions.

Risk averseness – this can be exhibited by existing and would be industry players looking at the risks of new investments and acceptance in target markets, and also by customers showing hesitance until the product or firm has a firmer track record.

Industry Recipes – these are cognitive maps shared by industry incumbents about the structure and demands of the industry, i.e. the rules of the game. The strength of industry recipes can limit openness to change.

Institutional Pressures – companies can experience strong pressure from institutions such as government, professional associations, trade unions, pressure groups, etc. prescribing acceptable behaviours and therefore restricting permissible strategies.

Resources

References

De Wit, B & Meyer, R 2010, Strategy Synthesis: Resolving Strategy Paradoxes to Create Competitive Advantage, 3rd Ed, South-Western Cengage Learning, UK

Hamel, G & Prahalad, CK 1994, ‘Competing for the Future’, Harvard Business Review, July-August

Hill, CWL & Jones GR 2010, Strategic Management Theory: an Integrated Approach, 9th Ed, South-Western Cengage Learning, USA

Porter, ME 1979, ‘How competitive forces shape strategy’, Harvard Business Review, vol. 57, no. 2, March-April

Porter, ME 1980, Competitive Strategy: Techniques for Analyzing Industries and Competitors, The Free Press, NY

Porter, ME 2008. ‘The Five Competitive Forces that Shape Strategy’, Harvard Business Review, January

Porter, ME & Kramer, MR 2011, ‘Creating Shared Value’, Harvard Business Review, vol. 89, no. 1-2, pp. 62-77

Prescribed Readings

Hill, CWL & Jones GR 2010, Chapter Two “External analysis: the identification of opportunities and threats”, in Strategic Management Theory: an Integrated Approach, 9th Ed, South-Western Cengage Learning, USA

Hill, CWL & Jones GR 2010, Chapter Seven “Strategy and Technology”, in Strategic Management Theory: an Integrated Approach, 9th Ed, South-Western Cengage Learning, USA