- Business or general or macro environment
The business environment of the firm consist of all the external influences that affects its decision and performance. Environmental influences can be classified into political, economic, social and technological , environmental and legal factors (“PESTEL”) .
Continuous scanning of the whole range of external influences might seem desirable but such extensive environmental analysis incurs high cost and creates information overload. The prerequisites for effective environmental analysis is to distinguish the vital from merely important. To do this let us return to the first principles. For the firm to make profit it must create value for customers. Hence, it must understand its customers. Second, in creating value the firm acquires goods and services from suppliers. Hence, it must understand its suppliers and manage relationship with them. Third the ability to generate profitability depends on the intensity of competition. Hence, the firm must understand completion. Thus, the core of the firms’ business environment is formed by its relationship with three sets of players: customers, suppliers and competitors. This is industry environment.
The starting point for industrial analysis is a simple question: what determines the level of profit in an industry? The profit earned by the firms in an industry are thus determined by three factors: - the value of the product to customers
- the intensity of competition
- the bargaining power of producers relative to their suppliers and buyers.
Analysing industry attractiveness
The basic premise that underlies industry analysis is that the level of industry profitability is neither random nor the result of entirely industry specific influences- it is determined by the systematic influences of the industry structure. For example the pharmaceutical industry produces highly differentiated products bought by price insensitive consumers and new products receive monopoly privileges in the form of patents.
The underlying theory of how industry structure drives competitive behaviour and determine industry profitability is provided by industrial organization (IO) economics. The two reference points are the theory of monopoly and the theory of perfect competition, which form the end points of the spectrum of the industry structures. Monopoly exists where an industry comprises a single firm protected by high barriers to entry and the monopolist can appropriate in profit the full amount of the value it creates. At the other extreme perfect competition exist where there are many firms supplying an identical product with no restrictions on entry or exit. Here, the rate of profit falls to a level that just covers firms cost of capital. In the real world, industries fall between these two extremes. The us market for chewing tobacco is close to be being a monopoly ; the Chicago grain markets are close to being perfectly competitive. Some manufacturing industries and many service industries tend to be oligopolies or even duopoly. By examining any principal structural features of any particular industry, it is possible to predict the type of competitive behaviour likely to emerge and the resulting level of profitability.
But in practice there are many features of an industry that determine the intensity of competition and the level of profitability. A widely used framework for classifying and analysing these factors was developed by Michael Porter of Harvard Business School. Porter’s five forces of competition framework views the profitability of an industry as determined by five...