Chap - 3 the Macro Envioronment

The Institute of Chartered Accountants in England and Wales, March 2009 75

Contents

chapter 3

The macro environment

Introduction

Examination context

Topic List1 The business environment

2 Environmental dynamics

3 PESTEL analysis

4 The international business context

5 Limits to globalisation of business

Summary and Self-test

Answers to Self-test

Answers to Interactive questions

Business strategy

76 The Institute of Chartered Accountants in England and Wales, March 2009

Introduction

Learning objectives Tick off Explain how a business collects and distributes environmental information in order to manage

its strategy

Analyse for a given situation the external factors which may impact on a business'sperformance and identify significant issues in the following areas:

Sustainable development

Global macroeconomic forces

International trade and financial systems

Government policies

Cultural environment

Identify the risks attached to operating a global business

Specific syllabus references for this chapter are: 1b, 3g.

Practical significanceThe wealth of many European countries, and of the businesses within them, can be attributed to their earlyindustrialisation and imperialism commencing in the 17th century. The USA caught up and overtook Europeduring the early 20th century. From the mid 20th century those gains have been gradually superseded by thedevelopment of emerging economies in Asia and Latin America. These have brought new markets and newchallenges which must be addressed by businesses from the developed economies if they are to survive.

Stop and thinkYou are early in your career as a professional accountant. Where in the world should you be working inorder to make the best of the opportunities over the next 40 years? Which industries around you are likelyto thrive and which to die?

Exactly the same questions are facing business strategists, albeit on a grander scale.

Working contextMany of your clients will be global businesses, or at least have some form of buying and selling relationshipwith overseas firms. Your firm may be required to:

Assist in transnational audits alongside professional colleagues from outside of your home country Assess the extra risks the client runs as a consequence of operating internationally Advise on taking-on international contracts

Syllabus linksEnvironmental analysis was covered in your Business and Finance paper under section 6 of the syllabus.However its coverage was at the level of core knowledge. In the Business Strategy examination you will berequired to apply it.

THE MACRO ENVIRONMENT


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Examination context

Exam requirementsThe scenarios in the majority of exam questions will require you to absorb and understand informationabout the external environment in which an organisation operates. You will also need to assess theimplications of the environment and changes in the environment for the strategic positioning and strategicdecisions of an organisation. To do this you will need to apply your knowledge of the tools and ideascovered in this chapter.

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1 The business environment

Section overview Strategy is concerned with matching the organisation to the threats and opportunities in its

environment.

The process of gathering and disseminating the necessary knowledge about a firm's externalenvironment is a specific example of knowledge management.

1.1 Importance of management understanding business environmentThe environment contains those factors 'surrounding the organisation'. Therefore it includes more than the'ecological' environment. In your answers you must ensure you discuss environmental factors such ascompetitors and legislation as well as factors such as environmental pollution and recycling.

To be viable (e.g. able to sustain itself through time) the organisation must achieve an appropriate 'fit' withthis environment. This includes:

Results that meet the expectations of its owners (shareholders, government, members etc)

Products and services that meet its clients' expectations at least as well as rivals'

Ability to remain within the legal and ethical codes of the societies it works in

Attractive as a place to work for its staff

Satisfying the needs of other powerful or influential stakeholders



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EXTERNALANALYSIS

INTERNALANALYSIS

CORPORATEAPPRAISAL

MISSION ANDOBJECTIVES

GAP

STRATEGICCHOICE

STRATEGYIMPLEMENTATION

REVIEW ANDCONTROL

STRATEGICANALYSIS

STRATEGICCHOICE

STRATEGYIMPLEMENTATION

Rational planning approach: Environmental appraisal is a one-off assessment which establishes theforces acting on the business at present and forecasts how these may develop during the years of the plan.

Strategic management approach: The need for environmental scanning. This is a continuousawareness by management of environmental issues enabling them to be routinely considered in decisionmaking.

Interactive question 1 Considering the business environment[Difficulty level: Intermediate]

For a professional accountancy practice, answer the following questions.

(a) What are the main external factors, in your view?

(b) How do these main environmental/external factors affect the strategies of the practice?

(c) In your view, how do managers perceive the environment of the organisation?

(d) How do you think managers incorporate environmental/external issues into decision-making?

See Answer at the end of this chapter.

1.2 Gathering and disseminating environmental informationAn effective system:

Gathers environmental information

Validates and corroborates the information

Disseminates the information so that people who need it can find it.

Business strategy


1.2.1 Sources of environmental information

Internal sources include:

Employees: Some will be following developments affecting the firm or their field of work, or havepast experiences and networks of contacts that can provide insights.

Internal records system: This will reveal comments of sales teams at meetings, revenue and costtrends at different locations, customer requests or complaints etc.

Formal information resources: Many firms may employ information resources specialists to createcurrent awareness reports e.g. large accountancy firms have technical departments that monitorchanges to regulations and the outcomes of adjudications, test cases and appeals.

External sources include:

Trade media: The magazines and journals specific to the industry or to particular business functions

Published accounts of rivals, suppliers and clients

Government statistical reports

On-line resources: Subscriptions to business information vendors, current awareness services(emails from vendors who monitor the media for articles containing keywords specified bymanagement)

Market reports: Published research from investment analysts, market researchers, tradedepartments of governments etc.

1.2.2 Validating environmental information

Methods:

Appointing an Information Officer with skills of 'librarianship'. to act as a central point of contactfor obtaining, sifting and relaying information

Appointing a database administrator for information stored and disseminated electronically, e.g. via anintranet, to check on the validity of postings.

Issues to consider in validating environmental information include:

Integrity of the source: internet gossip and market rumours lack integrity on their own

Forecasting and predictive record in the past

Degree of substantiation: is there more than one report or instance of this from independent sources?

Age of the information: how up to date is it?

Motivation of provider: does the provider have something to gain from convincing the firm of thisinformation?

1.2.3 Disseminating environmental information

Tacit knowledge refers to 'information the organisation does not know it has' i.e. it is known to very fewpeople and not easily available to the organisation as a whole. Explicit knowledge is information that hasbeen disseminated more widely.

Dissemination can be assisted by:

A well designed intranet with clear files and a search facility

Periodic briefing reports with a digest of the most significant information

Periodic seminars to brief management

Annual management development sessions at an internal or external business school to introduce anddiscuss new environmental issues



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2 Environmental dynamics

Section overview The ability of the business to plan, and its requirement for environmental information, will be

influenced by how predictable its environment is.

In Business Strategy the factors affecting this are given very precise meanings.

2.1 Complexity, predictability and turbulenceThe intensity of environmental issues varies from sector to sector and company to company.

DefinitionTurbulence: How changeable the environment is and how easy it is to predict.

Lynch (Corporate Strategy) presents turbulence as

Changeability Predictability

Changeability

Is the environment likely to change? There are two aspects to changeability.

Complexity: The variety of influences and conditions. These include regulatory, social and politicalfactors, technological change and internationalisation.

Novelty: The degree to which the environment presents new situations to be dealt with.

Predictability

Is it possible to forecast trends in the environment or at least make sensible predictions of discontinuouschange? Again there are two aspects:

Rate of change: In relation to the firm's ability to respond (slow to fast) to this (in other words,does the environment change at a slower pace than the organisation's ability to respond to it?)

'Visibility of the future': Is there reliable information to make forecasts for decision making?

The degree of turbulence will affect the amount of resources devoted to environmental assessment. Forexample, investment banks employ substantial research departments and each day begins with disseminationof relevant environmental information to traders and managers. Airlines also have research departmentswhich 'red flag' issues on a regular basis and also provide reports and forecasts as inputs into their strategicplanning process.

2.2 Scenario planning

DefinitionScenario planning: The development of pictures of potential futures for the purposes of manageriallearning and the development of strategic responses.

Business strategy


2.2.1 Introduction

Scenario planning is useful where a long-term view of strategy is needed and where there are a few keyfactors influencing the success of the strategy, e.g. in the oil industry there may be a need to form a view ofthe business environment up to 25 years ahead, and issues such as crude oil availability, price and economicconditions are critical. For example, Shell was the only major oil company to have prepared its managementfor dealing with the shock of the 1970s oil crisis through scenario planning and was able to respond fasterthan its competitors. Precision is not possible, but it is important to develop a view of the future againstwhich to evaluate and evolve strategies.

Scenario building attempts to create possible future situations using the key factors. The aim is to produce alimited number of scenarios so that strategies can be examined against them in terms of 'what if ...?' and'what is the effect of ...?' (basically a form of sensitivity analysis).

A car manufacturer could assess the impact of a 'Green Scenario' or a 'High Value Sterling Scenario' on itsbusiness. Financial models of the firm are often used in conjunction with this approach to assess impact onprofit. Although these provide a useful approach, it is important not to become too committed to onescenario; after all, they are only forecasts which might not in the event be valid.

2.2.2 Steps

Identify key forces, using techniques such as PEST analysis (see later) Understand the historic trend in respect of the key forces Build future scenarios, e.g. optimistic, pessimistic and most likely.

The scenarios generated are then 'plots' to be played out making managers consider future possibilities andencouraging them to think about strategy more flexibly.

Interactive question 2: Oil industry scenarios [Difficulty level: Intermediate]Oil producers use scenario planning extensively.

Requirements

(a) Identify the factors that make scenario planning popular with oil industries.

(b) Suggest some alternative scenarios that an oil producer might consider in its strategic planning.

3 PESTEL analysis

Section overview In your Business and Finance paper, you will have encountered PESTEL factors in your studies of the

environment of business.

This section looks in each PESTEL factor in more detail and identifies how each may impact on thestrategy of the organisation.

Later sections extend analysis to the global business environment.



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3.1 PESTEL analysis and underlying assumptionsPESTEL is a handy checklist environmental factors.

Political Economic Social/cultural Technological Ecological/environmental Legal

Worked example: Software in IndiaThe rapid emergence of the software industry in Bangalore in India has been made possible by acombination of technology (cheap and reliable telecommunications), economics (low labour costs in Indiacompared to industrialised nations) and political/social factors (the high level of education and thewidespread use of English).

PEST ANALYSIS

Economic factors Globalisation Business cycles Interest rates Inflation Unemployment Exchange rates

Sustainability issues, eg energy,natural resources

Pollution, etc Green issues, etc

Environmental factors

Technology Government and EU

investment and R&D policy New discoveries: products and

methods of production Speed of technology transfer Levels of R&D spending by

competitors Developments in other

industries that could transferacross

Social/demographic factors Income distribution Social mobility Levels of education/health Size of population Location Age distribution Lifestyle changes Consumerism Attitudes to work and leisure Green issues, etc

Economic factors Globalisation Business cycles Interest rates Inflation Unemployment Exchange rates

Sustainability issues, eg energy,natural resources

Pollution, etc Green issues, etc

Environmental factors

Business strategy


3.2 Political factorsPolitical factors relate to the distribution of power locally, nationally and internationally.

Political risk is the possibility that political factors will have an impact on the business's environment or prospects.The impact could be positive or negative, the issue is the uncertainty created.

Types of risk include the following.

Ownership risk: A company or its assets might be expropriated (or nationalised) by the state,normally with compensation. Confiscation is, effectively, expropriation without compensation.

Operating risk: Indigenisation/domestication. The firm may be required to take local partners.There may be a guaranteed minimum shareholding for local investors.

Transfer risk may affect the company's ability to transfer funds or repatriate profits.

Political risk: The government of the host country may change taxes or seek a stake in the businessto increase its power or to satisfy local public opinion.

Worked example: Oil companies in RussiaDrilling for oil and gas has never been for the faint hearted and as most of the easily recoverable fields arenow rapidly being run down, energy giants are being forced to confront bigger and bigger risks in an effortto replenish their reserves.

Once again, though, Russia has demonstrated that the political risks involved in ensuring that an oil giant hasa viable future can be every bit as challenging as the physical hurdles.

By subjecting Shell to an almost paralysing blizzard of ecological complaints on the giant Sakhalin project,Moscow has succeeded in securing control for its own Gazprom.

However, Shell and its Japanese partners simply cannot make Sakhalin work without Russian cooperation,so ceding 50% of the project to Gazprom is regarded as an acceptable price.

Walking away was not an option. Shell has already invested billions of dollars in this 'elephant' project andeven if it were ready to take such a large financial hit, the long-term need to find new sources of oil and gasmeans compromise is a necessity.

Following Shell's experience, BP is expected to face similar pressures on its joint venture with the Russiancompany TNK. Gazprom has its eyes on TNK's 50% and would like to secure majority control by takingpart of BP's share too.

While the challenges are great, they are nothing new. Muddling through with hostile political regimes is day-to-day stuff for oil giants.

As BP's chief executive, Lord Browne, remarked when discussing the difficulties of doing business in Russia,if not there then the alternative was violent, war-ravaged Africa. Looked at from this perspective, Russiaappears eminently hospitable.

Extract from article in UK Daily Mail 17 December 2006



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Sources of political risk

Source

The country This covers government stability, international relations, the ideology of thegovernment in power, the need for contacts, favouritism for local suppliers,political violence, governments' ability to change the law and operating conditions,governments' need to appease powerful stakeholders.

The product Consumer/basic products. High-tech components may have national security orarmaments implications. Oil extraction in some countries places the oil companiesnear regions of ethnic or political conflict.

The company Size, connections, reputation, influence on the environment.

Managing political risk

Companies, especially transnational corporations, might take measures to reduce political risk. These include:

Detailed risks assessments prior to investing in the country

Seeking protection from legal agreements with the host country or from bi-lateral trade agreementsbetween nations

Partnering with a local business to increase acceptance of the project and to lobby for political support

Raising finance for projects from host country to put local pressure on politicians to help safeguardinvestment

Operate under the auspices of international bodies e.g. World Health Organisation, UNICEF etc.

Share project with other firms to spread the risks between them

Avoid total reliance on one country e.g. oil companies extract oil from many countries to offset risksof interrupted supplies or spiralling costs

Lobbying for political support from home government for projects and to resolve issues

Support for political groups in host country that are favourable to the project

3.3 Economic factorsA typical economic factor that should be considered in strategic decision-making is the economic structureof a country. Countries typically progress from reliance on primary industries (e.g. agriculture, minerals,forestry) through manufacturing to tertiary services (e.g. financial and commercial sectors).

Lesser developed countries Reliant on a small number of products (e.g. crops or minerals) as themain export earner. Infrastructure is poor.

Implications:

Wealth and foreign exchange rate depend on yield of product andworld price of product.

Political actions aimed at securing control over incomes fromproduct either domestically (e.g. insurgent liberation forces) orexternally (e.g. develop cartels, invasion etc).

Newly industrialisingcountries

Rapid industrialisation and manufacturing base grows

Implications:

Infrastructure struggles to keep pace (e.g. power shortages, lack ofhousing, lack of roads, ports etc).

Large shifts in population towards areas of industry and away fromvillages.

Advanced industrial country There is a wide industrial base and a well developed service sector.

These affect overall wealth, financial stability and patterns of demand.

Business strategy


Business cycle

+

-0

Growthrate % Recovery Boom Recession

Depression

Long-term trend

Time

The long-term trend of industrialised economies is one of positive growth. The different phases of the cyclehave the following characteristics:

Recovery phase

Increased business confidence and investment causes growth to increase. Unemployment declines andconsumer confidence/spending rises.

Boom phase

Growth exceeds the long-term trend. Demand is too great, leading to rising prices of goods, balanceof trade deficits (as exports fall, imports rise), labour shortages and wage/factory price increases.

Recession phase

Demand falls, leading to increased unemployment and falling investment and business/consumerconfidence. Recession is often first seen in building and capital goods sectors.

Depression phase

Weak consumer and business spending/confidence. Unemployment in excess of normal levels withfalling (or even negative) inflation and wage cuts.

In setting strategy an organisation needs to consider where the economy is currently and where it isheading.

Long-term exchange rates' behaviour affect the relative competitiveness of imported and domesticallyproduced products and exports. A falling domestic exchange rate makes firm's exports morecompetitive and imported inputs more expensive. This may be determined by the value of key exportssuch as oil, minerals, crops, manufactured goods etc.

Interest rates (long-term and short-term) affect cost of finance and also levels of demand in theeconomy.

The economic infrastructure, for example access to payments systems, consumer and trade credit,access to venture and other capital, the quality of the stock exchanges.

3.4 Social/cultural factorsThese factors affect strategy in several ways:

They affect the market for products, e.g. religious proscriptions on food, financial services

They affect promotional strategies, e.g. language of adverts, considerations of imagery and decency

They affect methods of conducting business in countries, e.g. conventions of negotiation, givingand receiving of gifts, ensuring 'face' for contacts (i.e. maintaining self-respect and status)

They affect methods of managing staff, e.g. language differences, attitudes to managerial authority

They affect expectations of business conduct, e.g. extent of engagement with CSR, time horizon ofinvestment, engagement in political matters.



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Social factors include

Make-up of population: e.g. growth rate, proportion of old and young people

Family structure and size; the importance (or lack of it) of the extended family and relationshipswith non family members; the extended family provides contacts and work.

The role of women in the labour force and in society as a whole (expectations vary from society tosociety). In different cultures, gender stereotypes are more sharply drawn than in the industrialisedwest.

Extent of social mobility: the degree of social stratification and difference within each society andwhether people can move between them, the changes in size, wealth and/or status of different groupswithin the population and the geographical distribution of the population between regions and urban,suburban and rural areas.

Cultural factors are identified in the diagram below.

Worked example: EuroDisneyEuroDisney (Disneyland theme park and resort hotels) opened outside Paris, France, in April 1992. TheAmerican company, celebrating the success of theme parks in Los Angeles (California), and Orlando(Florida), and Tokyo (Japan 1983) thought that Western Europe was the next step. (Curwen, 1995).

Europeans, especially Britons, liked Disney's American parks, the sunshine, the amenities near the parks,and the reasonable accommodation costs. However, Paris was chosen as the European location because it

Business strategy


was at the centre of Europe's wealthiest region, and the French government offered inducements. Despiteopposition from French intellectuals, the project went ahead. Disney owned 49 percent of the shares.

The project plans assumed there would be a large number of visitors who would want to stay in the vicinityof the park.

The park opened on 12 April 1992. However, queues formed for rides that did not work and 'many of theemployees appeared to be struggling with the need to conform to Walt Disney's code of acceptablebehaviour'. (Curwen, 1995)

Curwen (1995) identified a number of difficulties, which we have listed below. Some were bad luck andsome were of Disney's own making.

In 1992, when the park opened, mainland Europe was entering a recession.

The value of the French franc rose, increasing the costs to Italian and British holidaymakers. (The UKleft the exchange rate mechanism in 1992, and Italy was temporarily suspended).

The weather EuroDisney should have considered this factor. Paris is in northern Europe.

Why should holidaymakers go to a rain-drenched version of a Disney theme park when they couldexperience the 'real thing' in sunny Florida (or California)?

A trip to EuroDisney would rarely provide more than a couple of days' outing: hence attendancefigures were optimistic.

Hotel occupancy rates were low (in part because of the excellent transport facilities to Paris).

Admission charges were seen as too high, and visitors 'broke the rules' by smuggling in their own foodand drink. Price resistance was a key issue.

Labour turnover was very high. French employees did not behave like Americans.

Cultural issues

Alcohol, as in the US theme parks, was banned. This impacted on the traditional French Sunday Lunchwhich is relaxed, conversational and where wine is served. Thus the full service restaurants sawreduced trade.

The management team were American, there were no European representatives.

At one point the French media called it a 'Cultural Chernobyl'.

The first year was catastrophic. The Disney corporation reconsidered its plans for further expansion of thesite. However, the French government, the bankers and Disney itself had good reasons for business tocontinue, and were able to persuade a wealthy Saudi investor to contribute.

Recovery

After this disastrous start, the company began to turn around, and it reported a profit in 1995. As well asfinancial support from a Saudi investor, and Disney's agreement to forego royalties the company began tochange. Pierre Bourguignon, the CEO, also attempted to institute cultural and structural change, and tochange the marketing.

The chain of command with reduced employees were empowered to take decisions. There were 220small groups with total profit responsibility.

All managers have to work on the front line once a week.

Admission prices were cut by 20 percent and cost of staying in the cheaper hotels was cut.

The catering was improved, with lower prices, more fast food, drinks and so on.



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Cultural issues

Reflecting greater sensitivity to national factors, EuroDisney targeted its marketing and promotionaloffers more closely to those factors.

The 'low-price' marketing strategy did not conform with the USA's strategy of offering a 'premium' qualityproduct, but the strategy brought in more people. However, attracting people to the more expensivehotels has been difficult.

By 1996 EuroDisney, by then renamed Disneyland Resort Paris, had become France's most-visited touristattraction. Management embarked on an ambitious expansion scheme opening Walt Disney Studios in 2002.

Hong Kong

In 2005 Disney opened its fifth, and smallest, Disney park on reclaimed land in Hong Kong. Disney owns43% and the Hong Kong government 57%. Initial cultural adaptation problems included:

Significant overcrowding at Chinese New Year as a an unanticipated wave of visitors arrived frommainland China

Protests from global environmental groups at the inclusion of shark's fin soup on the wedding menusat Disneyland HK

Criticisms from guests of wait times and overcrowding which had been endured more quietly at otherDisney resorts

Guests not respecting no-smoking and alcohol-free regulations.

In May 2007 it was reported that declining attendances at Disneyland HK and revenues below targets werejeopardising Disney's ability to raise finance to continue the planned investments in the resort. Managementwas contemplating significant promotional activity to turn it around.

3.5 TechnologyTechnological differences and change operate at three levels:

1. Apparatus, technique and organisation: How technology is used in the business, e.g. the use ofICT within the firm .

2. Invention and innovation: These affect the products being offered, e.g. the impact of higher powerhandsets on the development from mobile phone handsets to Personal Digital Assistants.

3. Metatechnology: A technology that can have a variety of applications, e.g. lasers are a technologythat have found uses in industry (welding), surgery (corrective eye surgery, key hole surgery),recorded music and software (CD, CD-ROM and DVD), and visual displays and light shows.

The strategic significance of the technological environment includes:

Technological base, and therefore customer and staff familiarity with it, varies across countries.Operations will have to take this into account.

Technological change challenges existing industry structure and competitive advantages and sostrategies to harness or evade it are necessary.

Technological change can render existing products obsolete. Therefore continuous R&D and learningis necessary to remain competitive.

Technological change creates uncertainty which may influence the approach to strategy formulationthat is adopted.

Business strategy


Worked example: Pulp and paperReports of the death of paper were rampant in the 1990s. However the paperless office never materialisednor yet have e-books. Even so the vast paper-and-pulp multinationals have been hard hit by the electronicage, especially in America. Mills are closing to buoy prices. Newsprint has been worst hit as circulation andclassified advertising at newspapers fall and the Wall Street Journal and other papers grow skinnier.

'The only grade of paper immune to technological substitution is tissue' such as bathroom or facial tissuesays investments analysts D.A. Davidson.

Restructuring in the paper industry is proceeding at a furious pace and have included:

Mergers between producers to eliminate slack capacity

Closure of capacity

Selling off of lumber farms and associated businesses (e.g. plywood, cartons, home furniture)

Development of businesses in non-affected areas such as corrugated cardboard used in packaging andexport industries.

As they thrash around for new direction, the pulp-and-paper giants of America and Europe must also dealwith the forces of globalisation. Brazil, with fast-growing eucalyptus trees, is the cheapest place to makepaper and China has recently gone from being a net importer to being a net exporter of newsprint.

At the same time, emerging economies also represent new markets that are not as hooked on email as thedeveloped world. However BlackBerrys and Dells will not keep a low profile in Brazil for ever.

Source: Economist March 2007

3.6 Ecological environment factorsClimate change

The 2007 report of the Intergovernmental Panel on Climate Change (IPCC) has forecast that global averagetemperatures by the end of the 21st century will have risen between 1.4C and 6.4C above the average for1990.

Global warming is forecast to cause polar ice caps to melt, leading to a chain of events including rises in sealevels and climate change.

The IPCC regards the actual level of average temperature at the end of the century to be dependent upon:

Actions taken by governments to reduce emission of carbon dioxide and ozone depleting gases intothe atmosphere.

The availability and use of technologies to reflect the sun's rays back into space such as vast reflectorsin low earth orbit or reflective particles scattered into low earth orbit.

The actual feedback mechanism in the ecosystem which may accelerate global warming as ice sheetscease to reflect sunlight, forests disappear and plants under stress become carbon dioxide producingrather than carbon dioxide absorbing.

Various socio-political consequences have been forecast.

Much greater cross-national cooperation to combat this common threat.

Re-mergence of state-funded nuclear energy as a solution following its international abandonment afterthe Chernobyl explosion in 1986 and the consequent escalating costs of safety.

Political conflicts are breaking out between developed countries and emerging economies over carbonemissions.

Inter-racial conflict and rise of fascism as populations migrate towards higher or more temperateclimates and are rejected by indigenous people.



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Land grab wars between USA, China and European states over Siberia and Alaska.

Increasing blame heaped on industrialised nations by impoverished states leading to calls for aid orother countries using and to gain political influence.

Breakdown in civil order as population squabbles over diminishing food and water supplies.

Main government policies are:

Reduce carbon emissions through targets set in cross governmental accords such as Kyotoagreements.

Penalisation of carbon creating industries through taxes levied on emissions or on fossil fuels used.

Investment in non-carbon creating technologies such as nuclear energy, wind and wave power andelectric or hybrid cars.

Making foreign aid dependent on acceptance of environmental policies by recipient countries.

Other ecological issues

Energy gap as fossil fuels diminish at a time when India and China are growing rapidly and demandmore energy.

Waste recycling issues as developed countries recognise the forecast use of landfill and also realisethat much landfill is hazardous waste (e.g. NiCad batteries, electronic circuitry, oil and solvents in carengines).

Bio-diversity issues as growing of cash crops and destruction of forests for grazing or building land alsodestroys species of plant, insects and animals.

Introduction of genetically modified organisms into the food chain leading to loss of species andpotentially hazardous future effects.

Implications for business strategy

Need to accept 'polluter pays' costs taxes on emissions and requirements that firms buy certificatesfrom refuse firms confirming recovery or destruction of materials the firm introduces into the supplychain

Increased emphasis on businesses acceptance of CSR and of principles of sustainable development;

Potential for economic gain from cleaning-up operations and selling surplus 'permits to pollute' tofirms that have not cleaned up

Potential competitive advantage from development of products that ecologically conscious buyers willfavour

Need to monitor ecology-related geo-political and legislative developments closely

3.7 Legal factorsLegal factors relate to the role of law in society and its role in business relationships. This can be assessed interms of:

Systemic factors: How effective is the legal system at enforcing contracts? To what extent are legaldecisions likely to be interfered with by politicians i.e. are the courts independent of government?How easy is it to get hold of legal advice? How speedy are the courts? To what extent is regulationdelegated? Are rights of private property genuinely enforceable?

Cultural factors: To what extent are business relationships conducted formally or informally? TheUSA is regarded as a litigious society; in Japan (partly because the small size of the legal profession),business is widely believed to be based more on long-term relationships.

Context and regulatory factors: cover civil and criminal law, laws relating to consumer protectionand advertising, employment and so forth. Furthermore, to what extent is competition promoted,regulated and enforced? Intellectual property rights are examples of specific issues which need to beconsidered.

Business strategy


Interactive question 3: Newspaper industry [Difficulty level: Exam standard]On 12 June 1993 The London-based newspaper The Sun dropped its cover price from 25p to 20p, claimingthat this would help its readers in the recession. The Daily Mirror responded quickly, cutting its price for asingle day to 10p, in an attempt to maintain circulation at the expense of lost revenue.

The resulting increased circulation of The Sun was no surprise for the tabloid market. However, how wouldthe circulation of the quality papers be affected by a similar strategy?

It has always been felt that broadsheets are price insensitive and therefore that a similar strategy adopted bya broadsheet publication would be of no benefit: branding was too strong. However, Peter Stothard, editorof The Times, had begun to disagree, feeling that readers did have brand loyalty but were also very muchinterested in value for money. A drop in price, he felt, could enhance a publication's value for money andtherefore on 6 September 1993 the price of The Times dropped from 45p to 30p.

Media analysts were unconvinced, maintaining that any resulting increased circulation would not offset thedecreased revenue, hence losses are the obvious result: CU200,000 for The Times and CU700,000 for TheSun per week (estimated). Analysts struggled to work out the rationale behind increased circulation bids.

One justification was that it was needed to combat the overall decline in the newspaper market a 20% fallover the previous thirty years according to leading accountants. The worst affected by this decline had beenthe tabloids.

Another argument was that it was done in order to affect Mirror Group Newspapers adversely during thesale of 55% of its shares in September.

Whatever the reason, the worry was that the price of The Sun would rise again and when it did the successor failure of the strategy would be shown by how many of the new readers (300,000) were retained. As thetabloid market is price sensitive, the signs were not good.

The outlook for The Times was slightly different: city analysts felt that a cut in price was necessary as thepaper was on a downward spiral, having lost its previous image. The price cut, they felt, was there to stay: itwas envisaged that more money would flow in from advertisers due to increased circulation.

Advertising was a major concern for newspapers in the recession: a typical tabloid received 20% of itsrevenues from circulation, with the rest coming from advertising. Broadsheets, on the other hand, had a50:50 split.

The total split on advertising spend had changed dramatically in the previous decade.

1981 1993Newspapers 66% 51%Television 20% 36%Radio 14% 13%

The initial reaction to this was to increase newspaper prices but obviously this had limited effect, hence thecuts by News International. Rupert Murdoch, it was felt, could sustain initial losses from profits elsewhere:his competitors would not be able to do so.

In 1993 The Daily Telegraph remained number one in the UK broadsheet market, its revenue declining byonly 1% compared with the previous year. This was achieved by a series of promotions including discountedholidays, as well as by its readers showing remarkable loyalty and an unwillingness to move.

The circulation of The Guardian had fallen by 5.6% and its market position had been affected as The Timesovertook it in the race for second position. However, the paper still remained popular.

The Independent, however, had been hardest hit. It was felt that the strategy of The Times could potentiallysqueeze it out of the market. If this were to be the result The Times was sure to benefit. The situationappeared to be mirroring the experience of the London Daily News a few years previously when it wasdriven out of business by the Evening News. Indeed, The Times would benefit both from increased circulationand increased advertising revenue if The Independent were to be terminated.

However, The Independent was struggling before The Times cut its price. Its circulation had declinedsignificantly since 1988 (20%) and it had been perceived as being 'weak' due to the lack of colourphotographs. Although this was corrected it meant that the price of The Independent had to be increased to



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compensate. This 5p rise was unfortunate, since it was implemented a matter of weeks after the reductionby The Times.

The Independent panicked and contacted the Office of Fair Trading, claiming that the price cut by The Timesamounted to predatory pricing and that this was not allowed. This complaint was not upheld: it would haveto be proved that the cut was aimed solely at The Independent and this would have been difficult to establish.

Furthermore, The Independent was not one of the financially strongest companies, having made a lossapproaching CU500,000 in the previous year. A takeover appeared to be a logical next step asThe Independent did have a small niche in the market. However, whoever bought it would have to overcomethe recent batterings which had left it with an image problem.

If newspapers had been allowed to expand into TV, then the competitive picture would have changedcompletely.

Requirement

Discuss the environmental factors that affected the newspaper industry, using the following headings.

(a) Political and Economic

(b) Social

(c) Technological

(d) Ecological

(e) Legal


4 The international business context

Section overview Few if any businesses are unaffected by global influences from competition, new markets or, at the

very least, cheaper sources of supply.

The view that certain nations have built-in advantages from low costs or harder-working staff hasgiven way to a more sophisticated view that home factors may configure to give advantages to ahandful of specific industries.

This is illustrated using the Porter Diamond model.

4.1 The importance of the global business environmentThe rapid industrialisation from the 18th century was a consequence of early involvement of merchants andbusinesses in trade. In the 21st century improved transportation and communications and cross-borderbusiness ownership have created, for most industries, a global business environment.

Global competition affects firms in several ways:

It provides the opportunities of new markets to exploit

It presents the threat of new sources of competition in the home economy from foreign firms

It offers an opportunity of relocating parts of business activity (or supply chain) to countries able toperform them better or more cheaply

It may drive cross border acquisitions and alliances

Business strategy


This leads management to make significant strategic investment decisions that rely on assessments of thestability and trends of the global business environment:

Development of products for international markets

Advancing credit to clients in international markets or investing in businesses and assets in hostcountries

Reliance of international sources for supplies of crucial inputs

Worked examples: Vehicle manufacture and call centresCase study (1) Global vehicle manufacturing

The history of vehicle manufacturing is an example of internationalisation and, to an degree, globalisation.According to Dicken, world output of motor vehicles in 1960 was c 13m units. In 2006 it had risen to 67m.

Fuelling this quantitative increase was vehicle production in Asia, Latin America and, in recent years,countries such as China and Thailand. According to the Economist (in 2005), global capacity stood at 80million units but actual production was 60 million, yet capacity utilisation needs to be 80% for most plantsto generate any decent profits.

Today the global automobile industry is characterised by extended global supply chains and cross nationalalliances between manufacturers. The Economist (January 2007) cites the example of vehicle developmentin General Motors:

'At the 2006 [North American International Auto Show] only one question seemed to matter; how soonwould the giant American car manufacturer go bust? At this year's show [2007] the subject of choice wasthe firm's nascent turnaround. The revival of the Saturn division cast light on some of the changes. Saturn[US] has consolidated its vehicle development efforts with those of GM's European arm, Opel and morebroadly the car maker's previously autonomous regional operations are now working together coherently.North America is developing the big pick-up trucks that dominate the market and Europe will handlemainstream passenger cars. The car unit of South Korea's Daewoo, now a GM subsidiary, will work onentry level models and Holden, and Australian subsidiary, will develop big saloons. If GM can make thisapproach work it will achieve economies of scale that only Toyota can match.'

Case study (2) Call centres and 'offshoring'

Call centres are being used increasingly by organisations seeking to centralise their customer servicefunctions. Increasingly call centres are located overseas.

Some firms that locate call centres in India, for reasons of the lower cost of graduate labour, give their staffelocution lessons in the appropriate regional accents, and update their staff on sporting events and soapopera plot lines for the sake of small talk. An example is GE Capital, whose US, UK and Australian armshave set up call centres in India. In some cases, more sophisticated functions are sent offshore.

4.2 The global corporation

DefinitionGlobalisation: The production and distribution of products and services of a homogenous type and qualityon a worldwide basis.

Levitt (The Globalisation of Markets 1983) described the development of a 'global village' in whichconsumers around the world would have the same needs and attitudes and use the same products. A globalcorporation would be one that operated as if the entire world was one entity, to be sold the same thingseverywhere.



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Levitt's focus was on the marketing aspects of globalisation. The global business corporation will also becharacterised by

Extended supply chains: Instead of making the product at home and exporting it, or setting up afactory in the host country to make it, the global corporation may factor out production so thatdifferent parts of the product (or service) originate in different countries. Womack et al (The MachineThat Changed The World) suggest that the globalisation of the automobile industry led the way for thismodel.

Global human resource management: This involves pan-national recruitment and development ofhuman resources.

Interactive question 4: A global corporation? [Difficulty level: Easy]Some would say that such purely global organisations are rare. Industry structures change and foreignmarkets are culturally diverse. Even within the USA, there is an enormous variety of cultural differences.Can you think of a global corporation that fulfils the requirements of the definition given above?


4.3 Ohmae's five Cs: factors encouraging development of globalbusinessOhmae (The Borderless World) has identified a number of reasons which might encourage a firm to actglobally arranged into a 'five C's' framework. (recall in Chapter 1 the discussion of three of these C's underOhmae's prescriptions for strategic thinking. By adding an extra two C's Ohmae extends his analysis intoglobal business).

The customer Are consumer tastes across the world converging upon similar productcharacteristics?

The company itself Selling in a number of markets enables fixed costs to be spread over a largersales volume.

Competition The presence of global competitors, who are enjoying the benefits of globalcommitment, could encourage a previously local or regional operator toexpand its activities.

Currency volatility Setting up assembly overseas is a way of reducing the exchange rate risksinherent in exporting and may also help to get around government imposedtrade barriers.

Country Locating business activities overseas may provide cheaper access to labour,materials and finance, along with the goodwill of host governments.

The continuing political acceptance of free-trade by international economies is essential to the success ofthese strategic investments.

4.4 Porter: The Competitive Advantage of NationsManagement developing strategy in a global environment needs to understand the competitive advantagesthey have over firms from other countries.

Porter (The Competitive Advantage of Nations) seeks to 'isolate the national attributes that foster competitiveadvantage in an industry'.

Porter identifies determinants of national competitive advantage which are outlined in the followingdiagram. Porter refers to this as the Diamond.

Business strategy


Role of factor conditions Basic factors Advanced factors

Human resources skills, (price, motivation,industrial relations)

Physical resources (land, minerals, climate, locationrelative to other nations)

Knowledge (scientific and technical know-how,educational institutions)

Capital (i.e. amounts available for investment, howit is deployed?)

Infrastructure (transport, communications,housing)

Basic factors include:natural resources,climate, semi-skilled andunskilled labour. Basicfactors are inherited, orat best their creationinvolves littleinvestment.

Advanced factorsinclude modern digitalcommunications, highlyeducated personnel,research laboratoriesand so forth. They arenecessary to achievehigh order competitiveadvantages such asdifferentiated productsand proprietaryproduction technology.

Role of demand conditions Comment

The home market determines how firms perceive,interpret and respond to buyer needs. Thisinformation puts pressure on firms to innovate andprovides a launch pad for global ambitions.

There are few cultural impediments tocommunication in the home market.

The segmentation of the home market shapes afirm's priorities: companies will generally besuccessful globally in segments which aresimilar to the home market.

Sophisticated and demanding buyers setstandards.

Anticipatory buyer needs: if consumer needsare expressed in the home market earlier thanin the world market, the firm benefits fromexperience.

The rate of growth: slow growing homemarkets do not encourage the adoption ofstate of the art technology.

Early saturation of the home market willencourage a firm to export.

Role of related and supporting industries Comment

Competitive success in one industry is often linkedto success in related industries. Domestic suppliersare preferable to foreign suppliers, as 'proximity ofmanagerial and technical personnel, along withcultural similarity, tends to facilitate free and openinformation flow' at an early stage.

This facilitates the generation of clusters. Theseare concentrations of many companies in the sameindustry in one area, together with industries tosupport them. For example, London in the UK is aglobal financial services centre, with aconcentration of banks, legal services, accountingservices and a depth of specialist expertise. SiliconValley is a further example.



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Role of strategy, structureand rivalry

Comment

Structure National cultural factors create certain tendencies to orientatebusiness people to certain industries. German firms have a strongpresence in industries with a high technical content.

Strategy Industries in different countries have different time horizons, fundingneeds and so forth.

National capital markets set different goals for performance. Insome countries, banks are the main source of capital, not equityshareholders.

When an industry faces difficult times, it can either innovatewithin the industry, to sustain competitive position or shiftresources from one industry to another (e.g. diversification).

Domestic rivalry With little domestic rivalry, firms are happy to rely on the homemarket.

Tough domestic rivals teach a firm about competitive success.

Each rival can try a different strategic approach.

Two other variables, chance events and the role of government, also play their part in determining thecompetitive environment.

4.4.1 Interactions between the determinants

The factors in the 'Diamond' are interrelated. Competitive advantage in an industry rarely rests on a singledeterminant.

Related industries affect demand conditions for an industry. For example 'piggy-back' exporting iswhen an exporting company also exports some of the products of related industries.

Domestic rivalry can encourage the creation of more specialised supplier industries.

4.4.2 Clusters

Related business and industries are geographically clustered. A cluster is a linking of industries throughrelationships which are either vertical (buyer-supplier) or horizontal (common customers, technology,skills). Clusters are supposedly a key factor in the competitive advantage of nations.

Within a country, the industry may be clustered in a particular area.

The Indian software industry is based in Bangalore.

The UK investment banking industry is largely based in London.

Business strategy


Interactive question 5: Why do banks cluster? [Difficulty level: Easy]It is easy to see why mining companies should congregate in a cluster around coal seams, or shippingservices would congregate around ports, but why should banks and software companies be clustered in thesame way, given plentiful IT and broad bandwidth communications?


4.4.3 Using Porter's Diamond to develop business strategies

Porter claims that firms gain competitive advantage from either of two sources.

Lower costs of supply to customers which result in higher profitability (cost leadership). Differentiated service or reputation resulting in higher prices and sales revenues (differentiation).

This is covered in more detail in Chapter 6.

Porter advises management to consider the diamond factors in their home country and to compare themwith the diamond factors available to rivals from other countries.

He offers the following prescription.

If the home diamond factors give a comparative cost advantage over those of foreign rivals thenmanagement should adopt strategies based on overall cost leadership. This may explain the strategiesof South Korean car manufacturers like Hyundai/Kia, Daewoo and SsangYong (the latter two beingrespectively offshoots of General Motors and Daimler Chrysler).

If the home diamond factors give a differentiation advantage over foreign rivals management shouldadopt strategies based on differentiation. This may explain why car manufacturers Mercedes, BMWand Audi tend to develop and initially produce their limousines in Germany but build vans and utilitycars in Spain, South Africa and Brazil.

If the diamond does not confer advantage over rivals then management must focus on sub-sections ofthe industry which large players may have overlooked or not be able to exploit commercially. Thismay explain the large number of private banks in Switzerland or the boutique sports car makers inItaly (Ferrari, Lamborghini, Maserati etc).

Interactive question 6: Chinese car industry [Difficulty level: Intermediate]At the Beijing Auto Show (in November 2006) China's car makers felt confident enough to show off notjust their newest low-cost runabouts, but also luxury and sports models, 'concept cars' showing futurepossible designs and even a few hybrid and electric vehicles. Local car makers in the world's third largestand fastest-growing car market would appear to have come of age.

Until recently many Chinese car makers built thinly-disguised copies of vehicles made by Volkswagen, GMand Toyota. In the past few years things have changed. In preparation for a push overseas local firms such asChery, Great Wall and Geely have proved they can develop their own vehicles too. Buying designs frominternational specialists and installing fancy robotic production lines means more than 100 new models willbe introduced in China this year. Their car makers have captured 27% of the market in China and willexport 75,000 vehicles to over 100 countries this year. Foreign car makers are worried by the Chinesefirms' ultra low prices. The latest Shanghai Maple, for example, with leather seats, anti-lock brakes, airconditioning and a 2 year warranty costs a mere $6,500. Foreign firms grumble that they cannot even buythe steel needed to make the car for that price.

How much of this miracle is the result of good business sense rather than special treatment granted tolocal firms is not entirely clear. A lot of early technology was borrowed. The government also offeredsupport to fledgling firms via direct investments and guaranteed loans. Universities provided technical help,especially in the development of expensive engines. The authorities even considered a law that wouldmandate a 50% share for local firms by 2010. Future legislation is likely to force foreign firms to do more



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research and development in conjunction with Chinese partners to ensure continued access to cutting-edgeengineering skills.

In a market where buyers are unashamedly experimental, brands have little value so far, except in theluxury segment. For most buyers cost is more important. With average retail process falling by $1,250 ayear producers are racing to cut costs, not improve quality. The number of faults per 100 cars made rosefrom 246 in 2005 to 338 in 2006. Reliability is likely to deteriorate further.

Chinese cars exported today mostly go to Africa, south-east Asia and the Middle East where expectationsare lower and price matters more.

Requirements

(a) Identify, using Porter's Diamond, the sources and nature of any competitive advantage enjoyed byChinese car manufacturers.

(b) Recommend a strategy for Chinese car makers based on this analysis.


5 Limits to globalisation of business

Section overview Despite the forecasts there are many impediments to the development of global businesses such as

protectionism. These are reviewed here.

Pursuing a global strategy is a source of risk to a business, either because the forecast opportunitydoesn't come about or because host governments change their policies towards 'foreign' investmentand render it no-longer valuable.

5.1 Political risks in international businessThe development of plans for international business will depend on the following factors:

1. The stability of the government. Rapid changes or political unrest make it difficult to estimate reactionsto an importer or a foreign business.

2. International relations. The government's attitude to the firm's home government or country mayaffect trading relations.

3. The ideology of the government and its role in the economy will affect the way in which the companymay be allowed to trade, and this might be embodied in legislation.

4. Informal relations between government officials and businesses are important in some countries.Cultivation of the right political contacts may be essential for decisions to be made in your favour.

Political risk is still relevant with regard to overseas investment, especially in large infrastructure projectsoverseas. History contains dismal tales of investment projects that went wrong, and were expropriated(nationalised) by the local government.

Suspicion of foreign ownership is still rife, especially when prices are raised.

Opposition politicians can appeal to nationalism by claiming the government sold out to foreigners.

Governments might want to re-negotiate a deal to get a better bargain, at a later date, therebyaffecting return on investment.

Business strategy


In addition to expropriation, there are other dangers:

Restrictions on profit repatriation (for example, for currency reasons) 'Cronyism' and corruption leading to unfair favouring of some companies over others Arbitrary changes in taxation Pressure group activity

Worked example: China's failure to attract new investmentIn eight months (of 2006) Intel committed more money to building production capacity in Vietnam than itcommitted to China in whole previous 10 years. Flextronics, a manufacturer of computer printers forHewlett-Packard already has vast facilities in China but it chose Malaysia for its latest investment. Yue Yuen,a Hong-Kong based shoemaker, has been ramping up output of trainers for Nike and Adidas and productionis increasing at the firm's factories in China and Vietnam, but output in Indonesia is growing the fastest.

These companies are not alone. In the calculus of costs, risks, customers and logistics that goes into buildingglobal operations, an increasing number of firms are coming to the conclusion that China is not necessarilythe best place to make things.

Analysts give two big reasons for why China is not top of the list for new factories.

Rising costs: Most development has taken place on China's Eastern costal strip and now costs of land,office space, utilities and labour are rising. Firms cannot find or retain managers versed in internationalproduction techniques and this causes rampant poaching and wage inflation.

Diversification: Many firms are reluctant to put more eggs in the same basket. Many firms are adopting a'China + 1 other country' strategy. Risks include increasing civil disturbances in China as the have-nots getleft behind by the haves; growing protectionist talk from the USA and EU which has already resulted in'anti-dumping duties' being imposed by the EU in October 2006. Another risk is the lack of legal protectionfor intellectual property in China which has led to designs being churned out by local factories underdifferent brand names. Capital intensive industries where cheap labour is not so valuable, such as chemicals,prefer Singapore. The rising currency (6.5% rise 2005-2006 and projected to rise 5% during 2007) is alsoanother concern because it will make exports from China less competitive.

Source: Economist January 2007

5.2 Protectionism in international tradeProtectionism is the discouraging of imports by, for example, raising tariff barriers and imposing quotas inorder to favour local producers. It is rife in agriculture.

Worked example: SugarAgriculture receives subsidies and government support in two of the world's most important areas, theUSA and the EU, despite the fact that this sector employs decreasing numbers of people (unlike Africa andIndia, where people live on the land).

Sugar is one of the most heavily protected. According to the World Bank, reform of sugar policy couldbenefit global welfare by $4.7bn pa.

The US maintains price controls and high prices costing US consumers $2bn per year. The sugarindustry, accounting for 61,000 jobs, is an intensive lobbyist. Florida, a sensitive state electorally, is abig culprit. The sugar lobby successfully excluded sugar from a free trade deal the US was negotiatingwith Australia and CAFTA (Central American Free Trade Agreement) Some have suggested that thesugar-lobby was behind the US's reluctance to endorse the World Health Authority's advice to limitsugar intake.

The EU has proposed reducing its subsidies to sugar companies by 39% for 2009, owing to a WTOruling that the EU's subsidy regime broke legal limits.



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Agriculture is a serious issue: campaigners such as Oxfam argue that opening agricultural markets todeveloping country producers could significantly alleviate global poverty. Sugar might find another use, asfuel alcohol.

Protectionist measures include:

Tariffs or customs duties: A tax on imports where the importer is required to pay either a percentageof the value of the imported good (an ad valorem duty), or per unit of the good imported (a specific duty).

Non-tariff barriers: Restrictions on the quantity of product allowed to be imported into a country. Therestrictions can be imposed by import licences (in which case the government gets additional revenue) orsimply by granting the right to import only to certain producers.

Minimum local content rules: A specified minimum local content of products should be made in thecountry or region in which they are sold to qualify as being 'home made' and so avoid other restrictions onimports. This leads manufacturers to set up factories in the country.

Minimum prices and anti-dumping action: To stop the sale of a product in an overseas market at aprice lower than charged in the domestic market, anti-dumping measures including establishing quotas,minimum prices or extra excise duties are used

Embargoes: A total ban or zero quota.

Subsidies for domestic producers: Financial help and assistance from government departments that givethe domestic producer a cost advantage over foreign producers in export as well as domestic markets.

Exchange controls and exchange rate policy: Regulations designed to make it difficult for importersto obtain the currency they need to buy foreign goods.

Unofficial non-tariff barriers: Administrative controls such as slow inspection procedures or changingproduct standards which are hard for foreign suppliers to anticipate and respond to.

5.3 Trade blocks and triadsTrading blocks

Currently, a number of regional trading arrangements (or 'blocks') exist, as well as global tradingarrangements. These regional trading groups take three forms.

1. Free trade areas members in these arrangements agree to lower barriers to trade amongstthemselves.

2. Customs unions these agree a common policy on barriers to external countries. Tariffs, taxes andduties are harmonised amongst members.

3. Common markets in effect, the members become one trading area. There is free movement of allfactors of production. The European Union has economic union as an aim.

Business strategy


Some major regional trade organisations are as follows.

Name Acronym Participating countries

North American Free Trade Agreementwww.nafta-sec-alena.org

NAFTA US, Canada and Mexico.

European Free Trade Association EFTA Norway, Switzerland, Iceland,Liechtenstein.

European Unionhttp://europa.eu.int

EU Ireland, Britain, France, Germany, Italy,Spain, Portugal, Finland, Sweden,Denmark, Luxembourg, Belgium, theNetherlands, Austria, Greece. In May2004, Poland, Hungary, the CzechRepublic, Malta, Cyprus, Estonia, Latvia,Lithuania, Slovakia and Slovenia.

Mercosurwww.mercosur.org

Brazil, Argentina, Paraguay and Uruguay(Chile is an associate).

Southern African Development Communitywww.sadc.int

SADC Angola, Botswana, Lesotho, Malawi,Mozambique, Mauritius, Namibia, SouthAfrica, Swaziland, Tanzania, Swaziland,Zimbabwe.

West African Economic and Monetary Unionwww.uemoa.int

UEMOA Ivory Cost, Burkina Faso, Niger, Togo,Senegal, Benin and Mali.

South Asian Association for RegionalCo-operationwww.saarc-sec.org

SAARC India, Pakistan, Sri Lanka, Bangladesh, theMaldives, Bhutan and Nepal.

Andean Communitywww.comunidadandina.org

Venezuela, Colombia, Ecuador, Peru andBolivia.

Association of Southeast Asian Nationswww.aseansec.org

ASEAN Indonesia, Malaysia, Philippines, Singaporeand Thailand.

Regional blocks such as those shown above only extend the benefits of free trade to their members. Theymay distort, and certainly do not represent, truly global trading patterns. Triad theory describes theinternational business environment as a limited number of 'superblocks'.

Worked example: Trading blocksThese trading blocks differ in their degree of integration and effectiveness.

The EU is the only such block with an elected parliament and a common currency (for some of itsmembers). The USA has a common currency between its individual states.

The ASEAN Free Trade Area has a total population of over 500 million, and a maximum tariff of 5percent (The Economist, 2 March 2002).

The EU has resisted the scrapping of agricultural subsidies. However, Mercosur is focusing on marketaccess. This renewed negotiations resulting from the failure of the WTO negotiations at Cancun, andwaning enthusiasm for a Free Trade Area of the Americas. Argentina, a member of Mercosur, is desperateto expand exports in order to generate growth to overcome its current financial crisis. Mercosur appearsto accept that it is pointless trying to change the EU's Common Agricultural Policy.



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The Triad

Rather than a globalised world or a federalised world of trading blocks some commentators see economicactivity as principally occurring in three main economic blocks: the USA, the EU and Japan. These do thebiggest value of their trade with each other.

Triad theory rejects the idea that homogenous products can be developed and sold throughout the world.Multinationals have to develop their products for the circumstances of each triad.

The Triad theory may be out of date. Japan was, in effect, in recession for 20 years from the mid 1980swhilst emerging markets, particularly those of China and India, but also Brazil, are likely to be some of theworld's largest and fastest growing markets. They still have a long way to go before per capita incomesreach the level of the Triad countries. They may form the fourth and fifth trading blocks, or perhaps thetriad will be superseded by their faster economic growth.

Business strategy


Summary and Self-test

Summary



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Self-testAnswer the following questions.

1 PDB Motors Ltd is a major UK car manufacturer with plants in the UK and Europe. It is seeking toexploit both the buoyant North American and Brazilian markets for car sales.

Suggest two reasons why it would be a logical strategy for PDB Motors Ltd to build an assembly plantin Mexico.

2 Social and technological factors always need to be assessed when analysing the environment withinwhich a business operates.

Give two examples of each of these factors which would be relevant to Busline Ltd, a UK operator ofcoach tours to Scarborough and Whitby.

Suggest how each of your factors may impact future demand.

3 Dunvegan Ltd

Dunvegan Ltd is a forestry company operating in the UK, mainly in Scotland. In addition to forests atvarious stages of maturity, the company also owns many hectares of undeveloped land.

So far Dunvegan Ltd's timber has consisted almost exclusively of spruce trees which producesoftwood used extensively in building work. Spruce sells for the equivalent of about CU200 per cubicmetre. However, genetic engineering has produced a remarkable new tree which has the growthcharacteristics of spruce, but which produces hard wood with the appearance and qualities ofmahogany. This species, the Maho spruce, should grow quite happily in Scotland and produceworthwhile crops after ten years, each Maho spruce tree producing about 2 cubic metres. Currently,mahogany sells for the equivalent of CU900 per cubic metre.

The company which developed the Maho spruce has ensured that the trees are sterile and has alsosuccessfully applied for world-wide patents on the genetic material. Seedlings are available only fromthat company at a cost of CU200 each.

Dunvegan Ltd is considering whether to invest in Maho spruce. Land already owned by the companywould be used and the company's planting and drainage equipment would be assigned temporarily tothe project. Because the seedlings are so expensive, relatively light planting would be used at 1,500seedlings per hectare. Annual maintenance and security would be CU1,000/hectare for each of the tenyears of the project. Dunvegan Ltd is considering planting 1,000 hectares with Maho spruce.

In the UK Dunvegan Ltd has three main competitors; mahogany is also imported from four countriesin the tropics where it is a valuable export. Some of the wood is from managed plantations, but someis from natural forest. Recently the price of mahogany has been rising as supplies become short andplantations have to be renewed. Dunvegan Ltd's accountant has read an article in a recent edition ofLumber About, the monthly trade paper of the timber business, in which the economic effects of theMaho spruce were discussed. If around 3,000-4,000 hectares were planted in the UK, then the price ofmahogany would be CU500 per cubic metre at the end of ten years. If around 2,000 hectares onlywere planted, then the price would be CU800 per cubic metre.

Requirement

From the viewpoint of an independent consultant, write a memorandum to the directors of DunveganLtd on the proposed Maho spruce plantation.

Your memorandum should include an environmental analysis. (20 marks)

Now, go back to the Learning Objectives in the Introduction. If you are satisfied that you have achievedthese objectives, please tick them off.

Business strategy


Answers to Self-test

1 Two reasons from the following:

This would allow PDB to take advantage of low labour costs in Mexico.

The location would be close to potential major markets, cutting transport costs and reducinglead time.

The NAFTA will avoid sales to the USA and Canada being subject to import restrictions.

It delivers sales growth prospects to a company facing a saturated European market.

2 Social factors

Two examples form the following:

Increasing car ownership (lower demand)

Higher proportion of older people in society (higher demand)

Cheap overseas packages available (lower demand).

Technological factors

Two examples from the following:

Development of high speed trains (lower demand)

More comfortable coaches being developed (higher demand)

Greater internet accessibility, creating more awareness of other travel options (lower demand).

3 Memorandum

To The Directors of Dunvegan Ltd

From Independent Consultant

Date Today

Subject Proposed Maho spruce plantation

The trading environment

The Maho spruce project is a ten-year project and it is important to try to predict how the tradingenvironment may change by the time the timber is ready to harvest. However, the time scaleobviously makes any predictions unreliable. The environment can first be analysed under the headingsPolitical, Economic, Social, Technological.

Political

Mahogany currently comes from four countries in the tropics. As it is a valuable export, thesecountries can be expected to be willing to sell mahogany irrespective of local political changes.

In the UK, however, there is growing concern about the deforestation of the tropics and suspicionabout the source of many hardwoods. It is possible that the UK or EC will tighten import legislation.Locally grown, renewable mahogany-substitute should be favoured in this ecologically-aware age.

Economic

Mahogany is principally used for building (window frames, etc) and furniture (veneers). Both of theseindustries are very sensitive to the health of the economy. It is difficult to predict the economic healthof the country ten years hence and so the project will have considerable risk and uncertainty.



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Social

If home-owning continues to grow, it is to be expected that demand for high quality materials will alsogrow. As mentioned under the political paragraph, using tropical hardwoods could become sociallyunacceptable and it would appear that the Maho spruce should provide a politically correct substitute.

However, some people may object to using genetically-engineered material.

Technological

Although Maho spruce has been patented, there is no reason why other manufacturers could notdevelop similar products. That would drive down the cost of seedlings (a major cost of theundertaking) and hence the price that would eventually have to be achieved to make the investmentpay.

Size of investment

The proposed investment is large, especially as there are many important factors which could changeover the project's life: the project is high risk even if not using innovative technology. Risk could bereduced by planting over several years rather than 1,000 hectares at one time. In that way theeconomics of the investment could be monitored and decisions taken about each slice of investment.

Naturally, this approach would delay the maturity of some of the crop. There is a risk that this wouldreduce the final income (if mahogany prices were to fall) but prices could also rise (strong reactionagainst natural mahogany, economic upturn). Delaying planting could also reduce the initial price ofseedlings as other bioengineering companies launch new products.

Summary

Insofar as environmental factors can be judged it would seem that Maho spruce should be a popularproduct. The main risk arises from technological advances which could produce similar cheapertimber.

However, the economics of the project are very dependent on the future price of Maho sprucetimber, its substitutes and the reactions of rivals.

My advice is as follows:

(i) Attempt to get the suppliers of Maho spruce to regulate sales of the seedlings.

(ii) Consider spreading out the investment instead of committing so much expenditure in the firstyear.

Business strategy


Answers to Interactive questions

Answer to Interactive question 1(a) External factors would include:

Rival accounting firms seeking to take clients themselves Other professional practices which may direct work toward us Regulations such as tax laws, accounting standards and audit standards The labour market for post-qualified and qualified accountants The general state of the economy and its effect on business

(b) These factors create opportunities and threats. New regulations create a need for professionaladvisers to provide guidance to clients. Competitors or a thriving labour market with higher paycreate threats (incidentally notice how you changed your perspective on the last point because youwould like to have the higher pay but you are calling it a threat for your firm). This illustrates howflawed the distinction between 'internal' and 'external' is when we discuss environmental analysis.

(c) This will depend on the managers psychological make-up. Some will see it as a tiresome bind thatmakes them have to keep changing things and also which makes it hard to plan or feel certain. Otherswill see it as invigorating.

A very interesting test of management is the extent to which they see themselves as powerless in thefaces of environmental changes or whether they believe they can shape and respond to them.

(d) Again, this varies. Some will avoid making decisions which could be affected by environmentaluncertainty, and will wait till it settles down (hence incrementalism). Some will simply ignoreenvironmental issues that cannot be proven. Perhaps a more balanced approach is to adopt strategiesthat would still deliver benefit under a number of environmental developments or perhaps haveseveral courses of action running at the same time, with each one designed to take advantage ofdifferent environments. In another context, energy companies invest in several different technologiesbecause they do not know how oil prices and environmental regulations will develop.

Answer to Interactive question 2(a) Oil producers adapted scenario planning techniques from their original military applications (notably in

planning for the aftermath of thermonuclear war) during the 1970s. This followed the oil price shockwhen the Arab states then at the centre of OPEC massively increased the price of oil and causedinflation and recession in industrialised Europe and North America. This decision was itself justified inpart as a response to the perceived support of oil consuming Western countries for support of theoccupation of Palestine and Egypt.

It was a response to the high turbulence (e.g. political shifts, vulnerability to economic factors etc.) anddynamism (e.g. speed of change of political landscape) in the oil industry. Furthermore the very longinvestment periods in the industry necessitated long-term strategic plans based on assumptions aboutthe future.

(b) Possible scenarios would incorporate a combination of:

War in the oil producing countries of the Middle East

Aggressive energy politics by countries such as Russia and Venezuela, holders of large reserves ofoil and gas

High energy demand from newly industrialising countries such as China and India

Increasing legislation in industrialised nations aimed at reducing use of carbon dioxide producingfuels



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Development of new energy sources such as clean coal, biomass fuel, wave and wind, and re-emergence of nuclear power

Discovery of new oil or energy reserves

Answer to Interactive question 33 Environmental analysis

The factors in the surrounding environment obviously played a significant part in the state of thenewspaper industry at that time. They were largely external and as such outside the control of theindividual newspaper companies, resulting in a reactive approach by the companies to such factors.

(a) Political and economic

One the major factors that influenced the industry was the recession. The industry had and stillhas two main sources of income revenue from individual sales coupled with revenue fromadvertising.

The tabloid newspapers were heavily reliant on advertising revenue (representing 80% of theirincome) whilst the broadsheets had a more even split. Both sources, however, suffered severelyin the recession as disposable income fell. Redundancies, pay freezes, and low inflation all resultedin a decrease in the income of the individual. The individual therefore cut back on what heperceived to be non-essential items, which may include his newspaper. Alternatively he willsearch for a cheaper alternative the tabloid or the free issue ('freebie').

Probably the broadsheets were relatively more influenced by government policies such asincreased taxes, which were aimed directly at individuals, decreasing their disposable income andhence decreasing demand for the more expensive newspaper. This obviously resulted in the pricedrop for The Times. To some extent this price drop prevented broadsheet customers desertingto cheaper tabloids, and also hit very hard the higher priced broadsheets, such as TheIndependent.

The decrease in the individual's net disposable income would have had a knock-on effect on theadvertisers: if the target market had less disposable income than previously was the case,companies would be less willing to advertise in newspapers, as it may not have been cost-efficient.

The overall effect was a sharp fall in revenues for newspaper companies. In order to overcomethis the newspapers attempted to increase volume by dropping sales price, hoping that theincreased volume would compensate for the overall decrease in revenues.

(b) Social

At that time, the newspaper market was split into two distinct sections the tabloids and thebroadsheets. Historically those individuals with lower incomes tended to buy the tabloids andthose with higher incomes tended to buy the broadsheets. Furthermore, the tabloids areintended to be sold to a more 'lower class' market than the broadsheets.

How the recession would have affected this is arguable. Some held that the 'higher class' imageattached to the broadsheets would prevent a switch by such readers to the cheaper 'lower class'tabloid. However, the tabloid editors believed that this was not the case: people are money-driven and the broadsheet readers would be just as price-sensitive as those of the tabloids hence a switch would be feasible.

General levels of literacy have declined and the public are less inclined to obtain their news fromnewspapers but instead rely on news bursts in the middle of radio and television programming.

(c) Technological

Changes in technology at that time had a considerable effect on the newspaper industry. Colourphotographs, a

Chap - 3 the Macro Envioronment

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