Analysing the External Environment: The European Brewing Industry (Case Study)

For many companies in the UK and the United States the period 1950 to 1970 seems in retrospect to have been one of almost uninterrupted straight-line growth in a relatively stable environment.

In such a situation managers look effective and perhaps they are effective if they “do the same thing over and over again and appoint successors in their own image”.

Then in the 1970s a big change took place. “Doing the same thing” became almost a recipe for corporate disaster. The reason for this was simple. Instead of being routine and fairly predictable, the business environment had become increasingly volatile; according to many managers the pace of change had accelerated (or so they thought). This process has continued into the 1990s, and at the same time many managers would claim that the complexity of the environment they face has also increased. As a consequence of these changes, the analysis of the external environment has become a key task within the process of creating strategy. An understanding of the nature of the environment is important, as is a familiarity with the tools and frameworks of analysis. The ability to understand the impact of the external environment upon an organisation will not guarantee strategic success, but to ignore the external environment is highly likely to make failure a distinct possibility.

Approaches to Analysing the External Environment

Monitoring and evaluating the external environment is an important issue for managers because changes in the external environment imply changes in strategy. Johnson and Scholes provide a framework for analysing the business environment.

Strategic Position

Assess the nature of the environment Audit environmental influences Identify key competitive forces Identify key opportunities and threats Identify competitive position

What are the principal trends in the European brewing industry?

The wide range of potential influences on an organisation and their interaction, make the job of assessing the general environment particularly difficult. In addition, each organisation is affected in different ways by changes in the environment. Factors that have a significant impact upon one organisation will have little effect on another. For example, the recent changes in the

funding of students in the UK is of particular concern to universities like Durham, but will have only a marginal impact on a retailer like Marks & Spencer.

PEST (Political; Economic; Social; Technological) analysis provides a systematic technique for analysing the business environment. It enables the manager to:

Summarise the most important influences of the business environment;

Evaluate the potential impact of these influences on the organisation. Using PEST analysis can help to highlight the biggest influences on the strategy of the organisation, both currently and in the future. These influences can be both positive and negative. In addition, influences often cross the divide between the four headings; the important point is that they appear somewhere in the analysis. The key is to identify and concentrate upon those factors/trends likely to have the biggest impact upon the future of the organisation. Johnson and Scholes outline some of the most likely factors.

1. What environmental factors are affecting the opposition?

2. Which of these are the most important at the present time? In the next few years?

A PEST ANALYSIS OF THE EUROPEAN BREWING INDUSTRY

POLITICAL

Harmonisation of duty rates across European Union member states Competition legislation - e.g. 1989 Monopolies and Mergers Commission report in the

UK Local production laws - like Reinheitsgebot in Germany Restrictions on containers - like the use of cans in Denmark

ECONOMIC

Different patterns of industry concentration across countries Growing trend towards cross-border mergers and acquisitions Low growth in consumption of beers

SOCIAL

Growing concerns about health issues and drink-driving Increasing acceptance of low alcohol drinks Importance of supermarkets in distribution and growth of own-label products Increasing acceptance of pan European brands

TECHNOLOGICAL

Economies of scale in brewing and distribution

The Importance of Competition

Whilst the general environment is important, the more immediate environment that surrounds most organisations is the competitive environment. The concern of most managers is upon the ways in which the competitive environment might have upon their own organisations. The foundations of competition as a norm go back to Adam Smith in the eighteenth century and Vilfredo Pareto in the nineteenth. According to these writers, competition potentially offers an optimal state in which resources are efficiently (if not necessarily fairly) allocated. Smith was so struck by the effectiveness of competition that he spoke of its working as an “invisible hand”. Under certain conditions (more or less the absence of barriers to entry) it would guide the selfish actions of individuals to the best outcome for society as a whole. Essentially firms compete in 2 ways:

They try to undersell one another and capture markets, customers and profits, through manipulating prices and lowering costs. This is termed “price competition”.

They compete through “non-price competition” by differentiating their products, marketing, and advertising, promoting, branding and otherwise attempting to retain their own customers and attract their rivals.

The fact that some businesses are earning above the normal rate of return for their industry attracts many competitors and imitators. The very process of competition provides a dynamic for the economic system. Entrants competing on price or non-price factors are at the same time a threat to existing competitors, a stimulus to develop new markets and products, and to lower cost processes. As well as providing an incentive or dynamic to the economy, competition provides information about opportunities for gain through the messages of prices and profits.

Analysing the Competitive Environment

Based on an understanding of this process, Michael Porter, of Harvard University, has built a framework to allow for the analysis of competition within a particular industry. Much of his approach builds on the work of Edward H Chamberlin, also of Harvard University, and Joan Robinson, of Cambridge University, who were pioneer analysts of non-price competition in the 1930s.

At the heart of Porter’s work is what economist’s refer to as the

Structure-Conduct-Performance paradigm

. To understand the competitive pressures of an industry you need to focus upon its structure - its underlying economics.

Structure ----> Conduct ----> Performance

of an industry of the competitors the profitability of the competitors

- its underlying within the industry & the industry as a whole

economics

The underlying economics include such factors as the numbers of competitors and how easy it is for firms to enter or leave the industry. For example, if there are lots of competitors, who can enter or leave the industry easily, who sell similar products and who are fully informed of each others strategies (the economists call this

perfect competition

), then it is unlikely in the long term that any firm will make massive profits. The competitive process described in the section above will ensure that prices and profits are reduced. In contrast, if there is only one firm in the industry and entry into the industry is difficult (the economists call this

perfect monopoly

) the profits are likely to remain high, unless customers find alternatives to the product. Whilst these two examples may be the (unrealistic?) extremes, the principle still applies to other industries. Porter goes on to argue that firms who come up with a better strategies than their competitors, by understanding and exploiting the conditions of the industry better than others, might be able to achieve a more profitable position in the long term - he calls this

sustainable competitive advantage

(of which more next week). What factors affect competition in an industry?

Source: Adapted from M. E. Porter, Competitive Strategy, Free Press, 1980, p. 4. Copyright by TheFree Press, a division of Macmillan Publishing Co., Inc. Reproduced with permission.

Threat ofThreat ofsubstitutessubstitutes

Potentialentrants

Threat ofThreat ofentrantsentrants

Suppliers

BargainingBargaining power power

Substitutes

Buyers

BargainingBargaining power power

COMPETITIVE RIVALRY

Figure 3.6 Five forces analysis

According to Porter, whether an industry produces a commodity or a service, or whether it is global or domestic in scope, competition depends on five forces. These forces, which go beyond the immediate competitors in the industry, are:

the threat of

new entrants

;

the existence of

substitute products

or services;

the bargaining

power of suppliers

;

the bargaining

power of customers

or buyers;

existing rivalry

within the industry; These five forces determine the ultimate profit potential of an industry as a whole. Within an industry, individual firms who develop particular strengths may be able to gain competitive advantage whatever the profit position of the industry as a whole is.

The ultimate strength of competition in an industry depends on the collective strength of these forces

: sometimes one will dominate; often it's a collection of two or three.

To understand which of these forces is likely to be most significant means investigating the underlying structural conditions that underpin them

. We can examine each force in turn, to identify the factors that might be important: Five Forces Analysis (1)Five Forces Analysis (1)

The threat of entry ...The threat of entry ...

Dependent on barriers to entry such as:Dependent on barriers to entry such as:

Economies of scaleEconomies of scale

Capital requirements of entryCapital requirements of entry

Access to distribution channelsAccess to distribution channels

Cost advantages independent of size (Cost advantages independent of size (egeg the the

“experience curve”)“experience curve”)

Expected retaliationExpected retaliation

Legislation or government actionLegislation or government action

DifferentiationDifferentiation

Five Forces Analysis (2)Five Forces Analysis (2)

Buyer power is likely to be high when:Buyer power is likely to be high when:

There is a concentration of buyersThere is a concentration of buyers

There are many small operators in the supplyingThere are many small operators in the supplyingindustryindustry

There are alternative sources of supplyThere are alternative sources of supply

Components or materials are a high percentage ofComponents or materials are a high percentage of

cost to the buyer leading to “shopping around”cost to the buyer leading to “shopping around”

Switching costs are lowSwitching costs are low

There is a threat of backward integrationThere is a threat of backward integration

Five Forces Analysis (3)Five Forces Analysis (3)

Supplier power is high when:Supplier power is high when:

There is a concentration of suppliersThere is a concentration of suppliers

Switching costs are highSwitching costs are high

The supplier brand is powerfulThe supplier brand is powerful

Integration forward by the supplier is possibleIntegration forward by the supplier is possible

Customers are fragmented and bargaining powerCustomers are fragmented and bargaining powerlowlow

Five Forces Analysis (4)Five Forces Analysis (4)

Threat of substitutesThreat of substitutes

Substitutes take different forms:Substitutes take different forms:

Product substitutionProduct substitution

Substitution of needSubstitution of need

Generic substitutionGeneric substitution

Doing withoutDoing without

Five Forces Analysis (5)Five Forces Analysis (5)

Competitive Rivalry is high when:Competitive Rivalry is high when:

Entry is likelyEntry is likely

Substitutes threatenSubstitutes threaten

Buyers or suppliers exercise controlBuyers or suppliers exercise control

Competitors are in balanceCompetitors are in balance

There is slow market growthThere is slow market growth

Global customers increase competitionGlobal customers increase competition

There are high fixed costs in an industryThere are high fixed costs in an industry

Markets are undifferentiatedMarkets are undifferentiated

There are high exit barriersThere are high exit barriers

Assessing each of the competitive forces in turn, by identifying the structural factors which are significant in each case, will allow an understanding of the dynamics of the industry (its underlying economics). As well as providing an insight into dynamics of the industry, this approach also allows individual companies to understand the directions from which they face the greatest competitive pressures - and tailor their strategies to meet these pressures. What are the main factors influencing the nature of competition within the European brewing

industry?

A FIVE FORCES ANALYSIS OF THE EUROPEAN BREWING INDUSTRY

Potential Entrants

Competitors from Japan or the USA

Potential Substitutes

Soft drinks e.g. Coca-Cola

Wine

Other leisure activities e.g. going to the cinema

Power of Suppliers

Suppliers (e.g. farmers and packaging companies) have little power

Power of Customers

Customer loyalty to local brews - e.g. Germany

Retailers - supermarkets have growing power as industry concentration increases

Tied Houses - until recently this was one way of reducing Customer Power in the UK

Existing Rivalry

Barriers to entry within EU are reducing leading to cross-border mergers

Industry concentration across Europe is still relatively low

Demand for brewed products is static/declining in most countries

Summary

Industry restructuring between existing competitors and the growing power of the supermarkets

are probably the main competitive forces in the industry at present.

Are the factors the same across all countries?

Whilst some pressures are best understood on a pan-European level, many of the structural conditions vary between countries - distribution structures and industry concentration being two major factors. So need to apply the 5 Forces Framework both at a pan-European level and at the level of individual countries to gain a full understanding. This example of differences between the pan-European level and individual countries highlights the necessity of understanding how the framework is to be used. Five Forces Analysis: Key Questions andFive Forces Analysis: Key Questions andImplicationsImplications

What are the What are the

key forces key forces

at work in the competitiveat work in the competitiveenvironment?environment?

Are there Are there

underlying forces underlying forces

driving competitivedriving competitiveforces?forces?

Will competitive Will competitive

forces forces

change?change?

What are the What are the

strengths and weaknesses strengths and weaknesses

ofofcompetitors in relation to the competitive forces?competitors in relation to the competitive forces?

Can Can

competitive strategy competitive strategy

influence competitiveinfluence competitiveforces (forces (egeg by building barriers to entry or reducing by building barriers to entry or reducingcompetitive rivalry)?competitive rivalry)?

The FFF allows the strategist to both understand the dynamics of their industry and to identify ways in which to respond to the pressures and forces identified

–

to change the strategy of the organisation.

How have the different brewing companies chosen to compete within the industry?

Whilst the Five Force Framework can give a good insight into the competitive dynamics of a particular industry or sector, most managers also need to understand how their organisation is positioned relative to the other competitors

within

the industry.

Strategic Group AnalysisStrategic Group Analysis

Strategic Group Analysis is useful to:Strategic Group Analysis is useful to:

Identify firms with similar strategic characteristicsIdentify firms with similar strategic characteristics

Therefore identify the most direct competitorsTherefore identify the most direct competitors

Identify mobility barriersIdentify mobility barriers

Identify strategic opportunities (“strategic spaces”)Identify strategic opportunities (“strategic spaces”)

Strategic threats and problemsStrategic threats and problems

Even within the same industry, not all competitors will be following similar strategies or competing directly against each other. Michael Porter suggests the use of

strategic group analysis

to identify the ways in which particular groups of companies compete within the industry. The key to this approach is to identify two or three sets of characteristics that seem to establish key differences between the companies or groups of companies. Johnson and Scholes highlight a range of possible characteristics: It is useful to consider the extent to which organisations differ in terms of

characteristics

such as:

Extent of

product (or service) diversity

Extent of

geographic coverage

Number of

market segments served

Distribution channels

used

Extent (number) of

branding

Marketing effort

(e.g. advertising spread, size of

salesforce)

Extent of

vertical integration

Product or service

quality

Technological leadership

(a leader or follower)

R&D capability

(extent of innovation in product or process)

Cost position

(e.g. extent of investment in cost reduction)

Utilisation of capacity

Pricing policy

Level of

gearing

Ownership structure

(separate company or relationship with parent)

Relationship to

influence groups

(e.g. government, the City)

Size

of organisation

Source: Adapted from M.E. Porter,

Competitive Strategy,

Free Press, 1980; and J.McGee and H.Thomas,

„Strategic groups: theory, research and taxonomy‟, Strategic Management Journal,

vol. 7, no. 2 (1986), pp.141-60.

Figure 3.8 Some characteristics for identifying strategic groups

Companies are also unlikely to compete for the same customers. People’s tastes and needs differ, so

not all products and services are likely to meet their requirements. By identifying these different requirements through

market segmentation analysis

, companies can change their strategies to more closely appeal to the needs of particular groups of customers, so defining a position within the market that is more favourable relative to the forces of competition. Again, Johnson and Scholes outline a range of criteria for market segmentation:

Type of factor

Consumer markets

Industrial/organisational

markets

Characteristics of

people/organisation

s

Age, sex, race

Income

Family size

Life cycle stage

Location

Lifestyle

Industry

Location

Size

Technology

Profitability

Management

Purchase/use

situation

Size of purchase

Brand loyalty

Purpose of use

Purchasing

behaviour

Importance of

purchase

Choice criteria

Application

Importance of purchase

Volume

Frequency of purchase

Purchasing procedure

Choice criteria

Distribution channel

Users‟ needs and

preferences for

product

characteristics

Product similarity

Price preference

Brand preferences

Desired features

Quality

Performance requirements

Assistance from suppliers

Brand preferences

Desired features

Quality

Service requirements

Figure 3.9 Some criteria for market segmentation

Using both strategic group and market segmentation analysis, we can gain further insight into the major trends affecting the European brewing industry.

STRATEGIC GROUPS AND MARKET SEGMENTS IN THE EUROPEAN BREWING

INDUSTRY

Strategic Groups

Two key parameters could be:

geographic coverage

of the company - from local to pan European or global companies;

extent of brand family

- from a single product to broad brand family.

This leads to an identification of a range of

strategic groups

:

global, broad brand family

companies e.g. Carlsberg;

European, broad brand family

companies e.g. Brasseries Kronenbourg, who are attempting

to become more international;

international, specialist or narrow brand family

, e.g. Grolsch

national broad brand family

companies e.g. Bass

local specialists

e.g. many German brewers or UK micro breweries

Customer Segments

One of the quickest growing sectors in the UK brewing industry, where brewers have traditional

links to public houses, is in “themed” family pubs, which provide play areas for children, whilst

their parents enjoy a drink. The growth of low alcohol drinks, speciality beers and own-label

brands all appeal to different types of customer.

Conclusion

This session has outlined a number of frameworks and techniques that can be used to assess the external environment facing a particular organisation or understand the dynamics of competition

within particular industries or markets. Next week’s session will focus more upon how

organisations can outline strategies to meet these challenges of competition.