UNIT 2Environmental Analysis: Need, Characteristics and categorization of environmental sectors; approaches to the environmental scanning process structural analysis of competitive environment; ETOP a diagnosis tool.

Concept of EnvironmentEnvironment literally means the surroundings, external objects, influences or circumstances under which someone or something exists. The environment of any organization is the aggregate of all conditions, events and influences that surround and affect it. Since the environment influences an organization in various ways, its understanding is of crucial importance.

Characteristics/Features of Environment1. Complex: The environment consists of a number of factors, events, conditions and influences arising from various sources. They interact with each other constantly and often produce an entirely new set of influences. It is not easy to state clearly as to what kind of forces constitutes a given environment. In other words, environment is a complex phenomena easy to understand in parts, but difficult to understand in its totality.2. Dynamic: The environment of an organization is dynamic and constantly changing. Changes in technology, government regulations, competitive forces etc. compel organizations to shift gears and change direction quite often. At times, there could be too many changes in too little time, leading to shocks and surprises in the market place.3. Multi- faceted: What shape and character an environment assumes depends on the perception of the observer. A particular change in the environment, or a new development, may be viewed differently by different observers. A same development may be seen as an opportunity by one company while another company may take it as a threat.4. Far reaching Impact: The environment has a far reaching impact on organizations. The growth and profitability of an organization depends critically on the environment in which it exists. Any change in the environment has an impact on the organization in several different ways.

Internal and External EnvironmentThe internal environment refers to all factors within an organization that impart strengths or cause weakness of a strategic nature. The external environment includes all the factors outside the organization which provides opportunities or poses threats to the organization. The environment in which an organization exists can, therefore, be described in terms of the opportunities and threats operating in the external environment apart from the strengths and weaknesses existing in the internal environment. The four environmental influences are opportunity, threat, strength and weakness.

General versus Relevant Environment

The external environment consists of all those factors which provide opportunities or pose threats to an organization. In a wider sense, the external environment encompasses a variety of factors, like: international, national and local economy; social changes; demographic variables; political systems; technology; attitude towards business; energy sources; raw materials and other resources; and many other macro level factors. Such a wider perception of the environment could be described as the general environment. All organizations, in some way or the other, are concerned about the general environment. But the immediate concerns of any organization are confined to just a part of the general environment, which is of high strategic relevance to the organization. This part of the environment could be termed as the immediately relevant environment, or simply, the relevant environment.

A conscious identification of the relevant environment enables an organization to focus its attention on those factors which are intimately related to its mission, purpose, objectives and strategies. Depending on its perception of the relevant environment, an organization takes into account those influences in its surrounding which have an immediate impact on its strategic management process. Having identified its relevant environment, an organization can systematically appraise it and incorporate the results of such an appraisal in strategic planning. In order to cope with the complexity of the environment, it is feasible to divide it into different components or sectors. Environmental Analysis or Environmental Scanning

In order to survive and flourish in a highly competitive and turbulent environment, every organization must strike a happy balance between environment, values and resources. Because organizations are open systems, environmental factors inevitably influence them and it is up to managers to ensure that this influence is harnessed in a positive way, leading to organizational success. Environmental analysis is the process of monitoring the organizational environment to identify both present and future threats and opportunities that may influence the firm ability to reach its goals. The process by which organizations monitor their relevant environment to identify opportunities and threats affecting their business is known as environmental scanning or environmental analysis. If properly used, environmental analysis can help ensure organizational success in many ways:

It helps firms to adjust to environmental change at the right time, that is, encashing opportunities as they arise and eliminating the negative impacts of environmental threats through proactive planning. It also helps the organization to come out with an early warning system to ward off threats from competitive forces and develop suitable strategies to turn problems into opportunities. It tries to improve organizational performance by making managers and divisional managers aware of issues that arise in the firm environment by having a direct impact on planning and by linking corporate and divisional planning. It helps strategists to focus on alternatives that help achieve predetermined goals and eliminate those opinions that are not in line anticipated opportunities or threats.

Environmental scanning can be defined as the study and interpretation of the political, economic, social and technological factors which influence a business, an industry or even a total market.

Approaches to Environmental Scanning ProcessKubr has suggested three approaches which could be adopted for sorting out information for environmental scanning. These approaches are systematic, ad hoc and processed form approaches.

1. Systematic Approach: Under this approach, information for environmental scanning is collected systematically. Information related to markets and customers, the changes in legislation and regulations which have a direct impact on an organizations activities, government policy statements pertaining to an organizations business and industry, and so on, could be collected continuously to monitor changes and take the relevant factors into account. Continuously updating such information is necessary for strategic management as well as operational activities.2. Ad hoc Approach: Using this approach, an organization may conduct special surveys and studies to deal with specific environmental issues from time to time. Such studies may be conducted, for example, when an organization has to undertake special projects, evaluate existing strategies, or devise new strategies. Changes and unforeseen developments may also be investigated with regard to their impact on the organization.3. Processed form Approach: To adopt this approach, an organization uses information in a processed form, available from different sources both inside and outside the organization. When an organization uses information supplied by government agencies or private institutions, it uses secondary sources of data and the information is available in a processed form.

Since environmental scanning is absolutely necessary for strategy formulation, organizations use different practical combinations or approaches to monitor their relevant environments. These approaches may range from an informal assessment of environmental factors to a highly systematic and formal procedure. Informal assessment may be adopted as a reactive measure to a crisis and ad hoc studies may be undertaken occasionally. A highly systematic and formal procedure may be used as a proactive measure for the anticipation of changes in environmental factors, and structured data collection and processing system may be used continuously.

Sources of Information for Environmental Scanning or Analysis

The various sources of information which are tapped for collecting data for environmental scanning could be classified in different ways. There could be formal and informal sources; verbal as well as written sources. In terms of origin, data sources could be external and internal. Given below are some of the important types of sources of information.

1. Documentary or Secondary Sources of Information, like, different types of publications. These could be newspapers, magazines, journals, books, trade and industry association newsletters, government publications, annual reports of competitors, companies, and so on.2. Mass Media such as radio, television and internet.3. Internal Sources, like, company files and documents, management information systems, databases, company employees, and so on.4. External Agencies, like, customers, marketing intermediaries, suppliers, trade associations, government agencies, and so on.5. Formal Studies conducted by employees, market research agencies, consultants and educational institutions.6. Spying and surveillance through ex employees of competitors, or by planting informers in rival companies.Strategists use different information sources depending on their needs for environmental scanning. Governmental publications though a rich and comprehensive source of information are usually available after a considerable time lag. Private sources, though relevant and timely are quite expensive to tap. Therefore, whenever a particular information source is used, it should be checked for its reliability, time frame, methods of data collection and analysis used, form of presentation, and so forth. Important sources of information for environmental scanning include the following:

International Sources World Development Report World Economic Survey Statistical Year Book Year Book of International Trade StatisticsGovernment Sources Census of India Five Year Plan Reports India Year Book Economic Survey Annual Survey of Industries Centre for Monitoring Indian Economy Reports Monthly Bulletins of RBI Yojana Indian Trade Journal Reports of Tariff Commission, NCAER, CII, FICCI, ASSOCHAMOther Sources The Bombay Stock Exchange Directory Kothari Industrial Directory Economic Times Financial Express Business Line Commerce / Capital Business Today Business World McKinsey Quarterly Harvard Business Review Fortune Economic and Political Weekly

Methods and Techniques Used for Environmental Scanning / AnalysisThere is a wide range of methods and techniques available for environmental scanning. Strategists may choose among these methods and techniques depending upon their decision. These techniques are discussed below:1. SWOT Analysis2. TOWS Matrix Analysis3. ETOP4. Other Techniques

1. SWOT ANALYSISSWOT stands for Strength, Weaknesses, Opportunities and Threats. SWOT analysis, a widely used framework to summarize a company situation or current position, was given by Albert Humphery. Any company undertaking strategic planning will have to carry out SWOT analysis: establishing its current position in the light of its strengths, weaknesses, opportunities and threats, while internal analysis provides information needed to identify strengths and weaknesses.

SWOT analysis stands at the core of strategic management. It is important to note that strength and weaknesses are intrinsic value creating skills or assets or the lack thereof, relative to competitive forces. Opportunities and threats, however, are external factors that are not created by the company, but emerge as a result of the competitive dynamics caused by or in the market. As its name states, a SWOT analysis examines four elements:

An opportunity is a favourable condition in the organizations environment which enables it to consolidate and strengthen its positions. An example of an opportunity is a growing demand for the products or services that a company provides.A threat is an unfavourable condition in the organizations environment which creates a risk for, or causes damage to, the organization. An example of threat is the emergence of strong new competitors who are likely to offer stiff competition to the existing companies in an industry.Strength is an inherent capacity which an organization can use to gain strategic advantage. An example of strength is superior research and development skills which can be used for new product development so that the company can gain a strategic advantage.A weakness is an inherent limitation or constraint which creates strategic disadvantages. An example of a weakness is overdependence on a single product line, which is potentially risky for a company in times of crisis.

Carrying out SWOT Analysis

An understanding of the external environment, in terms of opportunities and threats, and the internal environment, in terms of strengths and weaknesses, is crucial for the existence, growth and profitability of any organization. The first thing that a SWOT Analysis does is to evaluate the strengths and weaknesses in terms of skills, resources and competencies. The analyst then should see whether the internal capabilities match with the demands of the key success factors. The job of a strategist is to capitalize on the organization strengths while minimizing the effects of its weaknesses in order to take advantage of opportunities and overcome threats in the environment.

TOWS MatrixTOWS matrix is just an extension of SWOT matrix. TOWS stand for threats, opportunities, weaknesses and strengths. This matrix was proposed by Heinz Weihrich as a strategy formulation matching tool.TOWS matrix illustrates how internal strengths and weaknesses can be matched with external opportunities and threats to generate four sets of possible alternative strategies. This matrix can be used to generate corporate as well as business strategies. To generate a TOWS matrix, the following steps are to be followed:1. List external opportunities available in the company current and future environment, in the block on the left side of the matrix.2. List external threats facing the company now and in future in the block on the left side of the matrix.3. List the specific areas of current and future strengths for the company, in the strengths block across the top of the matrix.4. List the specific areas of current and future weaknesses for the company in the weaknesses box across the top of the matrix.5. Generate a series of possible alternative strategies for the company based on particular combinations of the four sets of factors. The four set of strategies that emerge are: SO Strategies: SO strategies are generated by thinking of ways in which a company can use its strengths to take advantage of its opportunities. This is the most desirable and advantageous strategy as it seeks to mass up the firm strengths to exploit opportunities. ST Strategies: ST strategies use a company strengths as a way to avoid threats. A company may use its technological, financial and marketing strengths to combat a new competition. WO Strategies: WO strategies attempt to take advantage of opportunities by overcoming its weaknesses. WT Strategies: WT strategies are basically defensive strategies and primarily aimed at minimizing weaknesses and avoiding threats.Strategies which utilize strength to take advantage of an opportunity are generally referred to as exploitative or developmental strategies. Strategies which use strength to eliminate a weakness may be referred to as blocking strategies which overcome a weakness to take advantage of an opportunity or eliminate a threat may be referred to as remedial strategies.The TOWS matrix is a very useful tool for generating a series of alternative strategies that the decision makers of the firm might not otherwise have considered. It can be used for the company as a whole or it can be sued for a specific business unit within a company. However, it may be noted that the TOWS matrix is only one of many ways to generate alternative strategies.At a practical level, the only difference between TOWS and SWOT is that TOWS emphasize the external environment while SWOT emphasizes the internal environment. Many organizations utilize a SWOT analysis to identify organizational strengths and weaknesses. SWOT analyses can be interesting, but what should you do with the resulting information? This is where the TOWS matrix becomes a useful tool. It is a simple but effective way to brainstorm specific strategies to address the results of your initial SWOT investigation. So, SWOT helps you in exploring the various opportunities and threats while TOWS helps you in devising the appropriate strategies with respect to the information identified in SWOT.Advantages and Limitations of SWOTAdvantages It is very simple conceptually, with its four box grid; It facilitates understanding and insight; It supports strategic thinking; It encourages organisations to spot opportunities that might otherwise be missed; It stimulates organisations to anticipate threats and take action now to minimise their impact; and It is flexibleLimitations It generates lengthy lists. Finding the necessary data can be time consuming and difficult; It uses no weights to reflect priorities. Data may be based on assumptions that turn out to be wrong.

Other TechniquesSome of the more popular ones in this category include Expert Opinion: Knowledgeable people are selected and asked to assign importance and probability ratings to various possible future developments. The most refined version, Delphi method, puts experts through several rounds of event assessment where they keep refining the assumptions and judgements.

Dynamic Modelling: Researchers build sets of equations that attempt to describe the underlying system. The coefficients in the equations are fitted through statistical means. Cross Impact Analysis: Researchers identify a set of key trends. The question is then put: event A occurs, what will be the impact on all other trends? The results are then used to build sets of chains, with one event triggering others. Demand / Hazard Forecasting: Researchers identify major events that would greatly affect the firm. Each event is rated for its appeal to each major public group in the society. The higher the event convergence/meeting and appeal the higher its probability of occurring. The highest scoring events are then researched further.

After implementing the environmental analysis process, management should continually evaluate and strive to improve it.

ETOP Environmental Threat and Opportunity Profile

ETOP is a process of dividing the environment into different sectors and then analyzing the impact of each sector on the organization. Environmental diagnosis is concerned with assessment of Environmental factors in term of these being opportunity or threat and their impact. It is related with indentifying opportunities and threats based on Environmental monitoring. ETOP is an important technique which is widely needed in Environmental diagnosis. The ETOP technique was suggested by Glueck.

Techniques for Preparing ETOPIt can be prepared in the following way

1. Identify the different components of relevant environment: The economic environment may be divided into rate of economic growth, rate of inflation, monetary policy, fiscal policy and so on or competitive environment may be divided into threats of entry and exit, competitive position of competitors, etc.2. Assessing importance of environmental factors: The degree of importance is allotted to the identified environmental factors. This can be in qualitative terms like high, medium, low or it can be quantified like 3, 2, 1. 3. Assessing impact factors: An environmental factor which is relevant may either present threats or provide opportunities depending upon the nature of environmental factors and their behaviour. Positive impact of a factor is an opportunity while negative impact is a threat.4. Combining importance and impact factor: Combination of importance and impact factor gives a clear picture of industry sector. If both variables have been quantified, these can be combined by multiplication.

Benefits of ETOP It helps to determine the key factors of threats and opportunities. Good tool to qualify the factors related to companys image. Can consider many factors for each special case.

Limitations of ETOP It does not show the interactions between the factors. It cant capture the complete picture of the dynamic environment. Its a subjective analysis tool.

Environmental Threat and Opportunity Profile (ETOP) for a Bicycle Company

Environmental SectorNature of ImpactImpact of each Sector

MarketIndustry growth rate is 7 to 8% per year; for sports cycle growth rate is 30%; largely unsaturated demand.

TechnologicalTechnological up gradation of industry in progress, import of machinery simple.

SupplierMostly ancillaries and associated companies supply parts and components; imported raw materials easily available.

EconomicGrowing affluence among urban consumers; promising export potential

RegulatoryBicycle industry a thrust area for exports

PoliticalNo significant factor

International Emerging threat from cheap imports from China

Up arrows indicate favourable impact; down arrows indicate unfavourable impact, while horizontal arrows indicate a neutral impact.

The preparation of an ETOP provides the strategists with a clear picture of which sectors (and the different factors in each sector) have a favourable impact on the organization. By means of an ETOP, the organization can see where it stands with respect to its environment. Such an understanding helps an organization in formulating appropriate strategies to take advantage of the opportunities and counter the threats in its environment.

PEST / STEP ANALYSIS

A PEST analysis is an analysis of the external macro environment that affects all firms. P.E.S.T. is an acronym for the Political, Economic, Social and Technological factors of the external macro environment. Such external factors usually are beyond the firms control and sometimes present themselves as threats. For this reason, some say the pest is an appropriate term for these factors. However, changes in the external environment also create new opportunities and the letters sometimes are re arranged to construct the more optimistic term of STEP analysis. Many macro environmental factors are country specific and a PEST analysis will need to be performed for all countries of interest. The following are examples of some of the factors that might be considered in a PEST analysis.

1. Political Analysis Political stability Risk of military invasion Legal framework for contract enforcement Intellectual property protection Trade regulations & tariffs Anti trust laws Pricing regulations Taxation tax rates and incentives Wage legislation minimum wage and overtime Work week Mandatory employee benefits Industrial safety regulations Product labelling requirements

2. Economic Analysis Type of economic systems in countries of operation Government intervention in the free market Comparative advantages of host country Exchange rates and stability of host country currency Efficiency of financial markets Infrastructure quality Skill level of workforce Labour costs Business cycle stage (eg., prosperity, recession, recovery) Economic growth rate Discretionary income Unemployment rate Inflation rate and interest rates

3. Social Analysis Demographics Class structure Education Culture (gender, roles, etc.) Entrepreneurial spirits Attitudes (health, environmental consciousness, etc.) Leisure interests

4. Technological Analysis Recent technological developments Technologys impact on product offering Impact on cost structure Impact on value chain structure Rate of technological diffusion

The number of macro environmental factors is virtually unlimited. In practice, the firm must prioritize and monitor those factors that influence its industry. Even so, it may be difficult to forecast future trends with an acceptable level of accuracy. In this regard, the firm may turn to scenario planning techniques to deal with high levels of uncertainty in important macro environmental variables.

PESTEL FRAMEWORK

Two more macro environmental factors are added to PEST Environmental and Legal factors, giving rise to a PESTEL framework. The external forces can be classified into six broad categories: Political, Economic, Social, Technological, Environmental and Legal Forces. Changes in these external forces affect the changes in consumer demand for both industrial and consumer products and services. These external forces affect the types of products produced, market segmentation strategies, the types of services offered, and choice of business. Therefore, it becomes important for the organizations to identify and evaluate external opportunities and threats so as to develop a clear mission, designing strategies to achieve long-term objectives and develop policies to achieve short-term goals.

Legal1. Monopolies legislation/Antitrust regulation2. Employment law3. Health and safety4. Product safety

Environment: Environment conservation and protection as an issue has gained prominence because of deteriorating environmental balance which is threatening the sustainability of life and nature. Largely, business is also held responsible for such situations as emissions from industries polluting the air, excessive chemical affluent drained out in water making it poisonous and unfit for use, usage of bio non-degradable resources affecting the bio-chain adversely and exposure of employees to hazardous radiations bring their life in danger. All these have been taken very seriously by different stakeholders in the society including the government and legislations and movements are creating pressure for an environment friendly business. These have far reaching implications for business ranging from the kind of business, the product being manufactured, how it is manufactured and how friendly it is for mankind and nature. Big companies like Coca Cola and Pepsi have also come under the purview of the society regarding the environmental hazards. If the charges on them of using chemicals beyond accepted levels for manufacturing soft drinks are confirmed, they will have a black spot on their names and business. So, it is important for the organisations to take care of the environment as well.

Legal: Licensing policies, quota restrictions, import duties, Forex regulations, restrictions on FDI flows, controls on distribution and pricing of commodities together made business difficult during license permit raj before the liberalization policy of 1991. However, with economic reforms things have changed and legal formalities have eased. Nevertheless with globalization, the rules of competition, trade mark rights and patents, WTO rules and implications, price controls and product quality laws and a number of other legal issues in individual countries have become important and therefore they need to be included while understanding the general environment.

INDUSTRY ENVIRONMENT ANALYSIS / INDUSTRY ANALYSISAn industry is a group of firms producing products that are close substitutes. In the course of competition, these firms influence one another. Typically, industries include a rich mixture of competitive strategies that companies use in pursuing returns which are above average. These strategies are chosen because of the influence of an industrys characteristics.

Compared with the general environment, the industry environment has a more direct effect on the firms strategic competitiveness and ability to earn above average returns. An industrys profit potential is a function of five forces of competition: the threats posed by new entrants, the power of suppliers, power of buyers, product substitutes and the intensity of rivalry among competitors. These five forces were given by Michael E Porter. A description of these five forces is given below:

1. Threat of New Entrants: New entrants are new comers to an existing company. They typically bring new capacity, a desire to gain market share and substantial resources. Therefore, they are threat to an established corporation. The threat of entry depends on the presence of entry barriers and the reaction that can be expected from existing competitors. An entry barrier is an obstruction that makes it difficult for a company to enter an industry. Some of the possible barriers are as following:

Economies of Scale: arise when unit costs fall as a firm expands its output. Scale economies in the production and scale of micro processors for example, gave Intel a significant cost advantage over any new arrival. Product Differentiation: A company which shows differentiation in its product line gains advantage over its competitors Capital Requirements: The need to invest huge financial resources in manufacturing facilities in order to produce on a large scale. Switching Costs or Sunk Costs Access to Distribution Channel Cost Disadvantages Independent of Size Government Policy: Governments can limit entry into an industry through licensing requirements by restricting access to raw materials Amount of Fixed Cost

2. Rivalry among Competitors: Firms within an industry are mutually dependent. The situation in an industry keeps changing with the actions and reactions of the constituent firms. The desire to be the market leader or to corner a larger market share leads to rivalry among competitors. The extent of the rivalry among competitors un an industry affects the competition within that industry. When the rivalry is weak, there is likely to be lesser competition; when such rivalry is high, the level of competition is higher. The dimensions of rivalry among competitors are several. Some of the major ones are described below:

Competitive Structure refers to the number of competitors, their size and their diversity. Different types of competitive structures have different implications for the existing firms and for the new entrants. Structures could either be fragmented or consolidated. A fragmented structure means that there are a large number of small or medium sized companies, none of them in a position to dominate the industry. This structure is characterized by low entry barriers and less or no differentiation in the product. A consolidated structure consists of a few large companies or of just one large firm. Such a structure has a closely knit group of companies whose actions and reactions are matched: the actions of one lead to reactions from others. Competitive actions of the competitors are under close watch by the others as they affect the distribution of market share. In some industries, the competitors may adopt a policy of live and let live, while in others, there might be cut throat competition leading to under pricing or severely fought competition battles on the basis of other factors such as delivery, advertising or after sale service. Diversity among competitors means that different firms in an industry have different ideas on the basis of which to compete, different set of goals to achieve, or different organizational cultures. An industry with greater diversity poses a higher challenge to existing firms or new entrants for devising competitive strategies. Demand conditions refer to the nature of the customer demand existing in an industry. A high demand or a growing demand tends to moderate competition as each firm has enough for it and need not grab it from others. Stagnant demand may lead to competitive strategies designed to snatch market share firm from others. Declining demand may cause companies to maintain their market shares. Existing firms or new entrants need to take the demand conditions in the industry into account for the purpose of formulating business strategies. Exit barriers restrict the firms in an industry and prevent them from leaving, even though the returns might be low or might even be sometimes negative. The exit barriers are economic, strategic or emotional factors preventing companies from moving out after divestment of their businesses. Economic factors could be the high investments committed to plant and equipment that no alternative usage and high fixed costs of exit. Strategic factors could be inter - linkages between the different businesses of a company such as a firm being its own supplier or buyer or different businesses sharing a common pool of resources. Emotional factors could be a sentimental attachment to a business, it being an ancestral business or one founded by the entrepreneur on his own, or unwillingness to part with a business owing to loyalty to employees or distributors.

3. Bargaining Power of Buyers: Buyers affect an industry through their ability to force down prices, bargain for higher quality or more services, and play as competitors against each other. A buyer or distributor is powerful if some of the following factors hold true A buyer purchases a large proportion of the sellers product or service. A buyer has the potential to integrate backward by producing the product itself Alternative suppliers are plentiful because the product is standard or undifferentiated Changing suppliers cost little The purchased product represents a high percentage of a buyers costs, thus providing an incentive to shop around for a lower price. A buyer earns low profits and is thus sensitive to costs and service differences

4. Bargaining Power of Suppliers: Suppliers can affect an industry through their ability to raise prices or reduce the quality of purchased goods and services. A supplier or supplier group is powerful if some of the following factors apply: The suppliers industry is dominated by few companies, but it sells to many (eg., the petroleum industry) Its products and services is unique or it has built up switching costs Substitutes are not only readily available (eg, electricity) Suppliers are able to integrate forward and compete directly with their present customers 5. Threat of Substitute Products or Services: Substitute products are those products that appear to be different but can satisfy the same need as another product. Tea can be considered as a substitute for coffee. If the price of coffee goes up high enough, coffee drinkers will slowly begin switching to tea. The price of tea thus puts a price ceiling on the price of coffee. The identification of possible substitute products or services means searching for products or services that can perform the same function, even though they may not appear to be easily substitutable.

The strength of the five forces may change over time as industry conditions change. These forces determine the intensity of competition and hence the profitability and attractiveness of an industry. The five forces model of competition expands the arena for competitive analysis. The objective of corporate strategy should be to modify these competitive forces in a way that improves the position of the organization. Based on the information derived from the Five Forces Analysis, management can decide how to influence or to exploit particular characteristics of their industry. The task facing manager is to recognize how the changes in the 5 forces give rise to new opportunities and threats and to formulate appropriate strategic responses.

Critical Success Factors (CSFs)

Managers are concerned about knowing those critical factors which lead to success for their organization. Critical Success Factors (CSFs), sometimes referred to as strategic factors or key factors for success, are those which are crucial for organizational success. When strategists consciously look for such factors and take them into consideration for strategic management, they are likely to be more successful, while putting in relatively less efforts.

The concept of "success factors" was developed McKinsey & Company in 1961. The process was refined into critical success factors by John F. Rockart between 1979 and 1981. CSFs are the essential areas of activity that must be performed well if you are to achieve the mission, objectives or goals for your business or project. By identifying your Critical Success Factors, you can create a common point of reference to help you direct and measure the success of your business or project. As a common point of reference, CSFs help everyone in the team to know exactly what's most important. And this helps people perform their own work in the right context and so pull together towards the same overall aims.

For a shoe manufacturing company may consider the following CSFs: high manufacturing quality, cost efficiency, sophisticated retailing, a flexible product mix and creation of a product image. A courier service, for instance, is critically dependent on three factors: speedy dispatch, reliability and price. These examples indicate that if organizations keep in view the relevant CSFs, these can be used for objective setting as well as for exercising a strategic choice.

Rockart has applied the CSFs to several organizations through a three step procedure for determining CSFs. These steps are: To generate the success factors (What does it take to be successful in business?) Refining CSFs into objectives (What should the organizations goals and objectives be with respect to CSFs?) And, identifying measures of performance (How will we know whether the organization has been successful on this factor?)

Features of CSFs A set of CSFs is the result of asking the question: what do we need to do in order to be successful in a particular context. Critical success factors are elements that are vital for a strategy to be successful. A critical success factor drives the strategy forward; it makes or breaks the success of the strategy, (hence critical). Strategists should ask themselves 'Why would customers choose us?' The answer is typically a critical success factor. CSFs could also be generated internally through creative techniques such as brainstorming. The use of CSFs in objectives setting and strategic choice distinguishes the successful organizations from the unsuccessful ones.Key Performance Indicator (KPI)

A performance indicator or key performance indicator (KPI) is a type of performance measurement. An organization may use KPIs to evaluate its success, or to evaluate the success of a particular activity in which it is engaged. Key Performance Indicators, also known as KPI or Key Success Indicators (KSI), help an organization define and measure progress toward organizational goals. Once an organization has analyzed its mission, identified all its stakeholders, and defined its goals, it needs a way to measure progress toward those goals. Key Performance Indicators are those measurements.Key Performance Indicators are quantifiable measurements, agreed to beforehand, that reflect the critical success factors of an organization. They will differ depending on the organization. A business may have as one of its Key Performance Indicators the percentage of its income that comes from return customers. A school may focus its Key Performance Indicators on graduation rates of its students. A Key Performance Indicator for a social service organization might be number of clients assisted during the year.Accordingly, choosing the right KPIs relies upon a good understanding of what is important to the organization. 'What is important' often depends on the department measuring the performance - e.g. the KPIs useful to finance will be quite different from the KPIs assigned to sales. Whatever Key Performance Indicators are selected, they must reflect the organization's goals, they must be key to its success, and they must be quantifiable (measurable). Key Performance Indicators usually are long-term considerations.

Key Performance Indicators Reflect the Organizational GoalsAn organization that has as one of its goals "to be the most profitable company in our industry" will have Key Performance Indicators that measure profit and related fiscal measures. "Pre-tax Profit" and "Shareholder Equity" will be among them. However, "Percent of Profit Contributed to Community Causes" probably will not be one of its Key Performance Indicators. On the other hand, a school is not concerned with making a profit, so its Key Performance Indicators will be different. KPIs like "Graduation Rate" and "Success In Finding Employment After Graduation", though different, accurately reflect the schools mission and goals.

Categorization of indicatorsKey performance indicators define a set of values used to measure against. KPIs can be summarized into the following sub-categories: Quantitative indicators that can be presented with a number. Qualitative indicators that can't be presented as a number. Leading indicators that can predict the outcome of a process Lagging indicators that present the success or failure post hoc Input indicators that measure the amount of resources consumed during the generation of the outcome Process indicators that represent the efficiency or the productivity of the process Output indicators that reflect the outcome or results of the process activities Directional indicators specifying whether or not an organization is getting better.

Key performance indicators, in practical terms and for strategic development, are objectives to be targeted that will add the most value to the business. These are also referred to as 'key success indicators'. Key performance indicators (KPIs) are ways to periodically assess the performances of organizations, business units, and their division, departments and employees. Accordingly, KPIs are most commonly defined in a way that is understandable, meaningful, and measurable.KPI examples Marketing - Some examples are:1. New customers acquisition.2. Demographic analysis of individuals (potential customers) applying to become customers, and the levels of approval, rejections, and pending numbers3. Status of existing customers4. Customer attrition5. Turnover (i.e., revenue) generated by segments of the customer population6. Outstanding balances held by segments of customers and terms of payment7. Collection of bad debts within customer relationships8. Profitability of customers by demographic segments and segmentation of customers by profitabilityStrategic Groups AnalysisStrategic groups are conceptually defined clusters of competitors that share similar strategies and therefore compete more directly with one another than with other firms in the same industry. They are conceptually as they are not formally identified groups or part of an industry association. Rather they are identified on the basis of a set of strategic dimensions, such as, technological leadership, the degree of product quality, pricing policies, the choice of distribution channels, and the degree and type of customer service. These strategic dimensions define a firms business strategy in an industry. So, if the competitors in an industry can be grouped according to similarities of strategy then they constitute a distinct strategic group.Industries vary according to the business strategies that are employed by the constituent firms. Some industries are homogeneous in the sense that the constituent firms seem to be following quite similar strategies and could be grouped into one single strategic group. On the other hand, some industries tend to be heterogeneous as they consist of multiple strategic groups, each group, following similar strategies. It would be wrong to consider all industries as similar and conduct an industry analysis on the basis of this assumption. Strategic group analysis serves the purpose of identifying the strategic groups and then analyzing the industry from the viewpoint of the differences in the business strategies employed. This facilitates a direct comparison among the group of firms that compete directly with each other. Strategic group analysis serves the useful purpose of identifying and classifying firms on a basis that really matters. Industry and competitor analysis become more meaningful when done on the basis of strategic groups identification.

Competitive Profile Matrix (CPM)CPM is an essential strategic management tool to compare the firm with the major players of the industry. It gives the clear picture to the firm about their strong points and weak points relative to their competitors. The CPM score is measured on basis of critical success factors; each factor is measured in same scale meaning the weight remains the same for every firm, only rating varies. The best thing about CPM is that it includes your firm but also your competitors, thus making comparison easier. The competitive profile matrix consists of following attributes:

Critical Success Factors: are extracted after deep analysis of external and internal environment of the firm. Obviously there is something good and bad in the external and internal environment of the firm. The higher rating shows that the firms strategy is doing well to support this critical success factor and lower rating means that the firm strategy is lacking to support the factor.

Rating: in CPM represent that the firms approach/efforts toward the CSFs. Highest the rating better the response of the firm towards the CSF, ranging from 1.0 to 4.0 and can be applied to any factor. There are some important points related to rating in CPM, which are:

Rating is applied to each factor. The response which is poor is represented by 1.0. The response which is average is represented by 2.0. The response which is above average is represented by 3.0. The response which is superior is represented by 4.0.

Weight: attribute in CPM indicates the relative importance of factor to being successful in the firms industry. The weight ranges from 0.0, means not important and 1.0 means important. Sum of all assigned weight to factors must be equal to 1.0 otherwise the calculation would not be considered as correct.

Weighted Score: value is the result achieved after multiplying each factor rating with the weight.

Total Weighted Score: The sum of all weighted score is equal to the total weighted score. The final value of total weighted score should be between the ranges 1.0 (low) to 4.0 (high). The average weighted score for CPM is 2.5; any company whose total weighted score falls below 2.5 is considered as weak. The company with total weighted score above 2.5 is considered as strong in position. Another benefit of CPM is the firm with higher total weighted score is considered as the winner among the competitors.

Competitive Profile Matrix ExampleIn this example, advertising and global expansion are the most important critical success factors, as indicated by a weight of 0.20. Avons and LOreals product quality is superior, as evidenced by a rating of 4, LOreals financial position is good, as indicated by a rating of 3, Procter and Gamble is the weakest firm overall, as indicated by a total weighting score of 2.8.

Critical Success FactorsWeightAVON

Rating ScoreLOREAL

Rating ScorePROCTER&GAMBLE

Rating Score

Advertising0.201 0.204 0.803 0.60

Product Quality0.104 0.404 0.403 0.30

Price Comp.0.103 0.303 0.304 0.40

Management0.104 0.403 0.303 0.30

Financial Position0.154 0.603 0.453 0.45

Customer Loyalty0.104 0.404 0.402 0.20

Global Expression0.204 0.802 0.402 0.40

Market Share0.051 0.054 0.203 0.15

Total1.00 3.15 3.25 2.80

In this example, only 8 CSFs are included for simplicity. More other factors like, breadth of product line, effectiveness of sales distribution, patent advantages, location of facilities, production capacity and efficiency, experience, union relations, technological advantages, e commerce expertise, etc. can also be included.

In the above example, just because one firm receives a 3.2 rating and another receives a 2.8 rating in a Competitive Profile Matrix, it does not follow that the firm is 20% better than the second. Number reveals the relative strength of firms, but their implied precision is an illusion. Numbers are not magic. The aim is to arrive at a single number but rather to assimilate and evaluate information in a meaningful way that aids in decision making.

External Factor Evaluation Matrix (EFE): Industry AnalysisExternal Factor Evaluation matrix can be defined as the strategic tool to evaluate external environment or macro environment of the firm which includes economic, social, technological, government, political, legal and competitive information. The EFE Matrix can be developed in five steps: 1. List key external factors as identified in the external-audit process. Include a total of from eight to ten factors, including both opportunities and threats affecting the firm and its industry. List the opportunities first and then the threats. Be as specific as possible, using percentages, ratios, and comparative numbers whenever possible.2. Assign to each factor a weight that ranges from 0.0 (not important) to 1.0 (very important). The weight indicates the relative importance of that factor to being successful in the firm's industry. Opportunities often receive higher weights than threats, but threats too can receive high weights if they are especially severe or threatening. The sum of all weights assigned to the factors must equal 1.0.3. Assign a 1-to-4 rating to each key external factor to indicate how effectively the firm's current strategies respond to the factor, where 4 = the response is superior, 3 = the response is above average, 2 = the response is average and 1 = the response is poor. Ratings are based on effectiveness of the firm's strategies. Ratings are, thus, company based, whereas the weights in Step 2 are industry based. It is important to note that both threats and opportunities can receive a 1, 2, 3, or 4.4. Multiply each factor's weight by its rating to determine a weighted score. 5. Sum the weighted scores for each variable to determine the total weighted score for the organization.Regardless of the number of key opportunities and threats included in an EFE Matrix, the highest possible total weighted score for an organization is 4.0 and the lowest possible total weighted score is 1.0. The average total weighted score is 2.5. A total weighted score of 4.0 indicates that an organization is responding in an outstanding way to existing opportunities and threats in its industry. In other words, the firm's strategies effectively take advantage of existing opportunities and minimize the potential adverse effect of external threats. A total score of 1.0 indicates that the firm's strategies are not capitalizing on opportunities or avoiding external threats.

An example External Evaluation Matrix (EFE) for Wal Mart

KEY EXTERNAL FACTORSWEIGHTRATINGWEIGHTED SCORE

Opportunities

1. Ease of shopping 0.1440.56

2.Internet shopping 0.1440.56

3.Asian Markets 0.1230.36

4.Recovery of global economy0.1030.30

5.Free Trade0.0820.16

KEY EXTERNAL FACTORSWEIGHTRATINGWEIGHTED SCORE

Threats

1. Local Economy critics 0.1230.36

2.Technology Making Products Obsolete 0.0620.12

3.Not following consumer preferences 0.1030.30

4.Regulations of respective countries0.0620.12

5.No Union0.0820.16

Total Weight Score1.003.00

By adding the weighted score of various opportunities and threats of Wal-Mart, we get the total weighted score of 3. Here it should be noted that the highest possible total weighted score of a firm is 4 whereas the lowest possible total weighted score is 1. The total weighted score remains in the limit of 1 to 4 regardless the total number of opportunities and threats. Similarly, the average total weighted score is 2.5. If the total weighted score of a company is 4, it means that the company is effectively taking advantage of existing opportunities and is able to minimize the risk. On the other hand, the total weighted score of a company is 1, it means that the company is not able to take advantage of current opportunities or avoid external threats.

In the case of Wal-Mart, the total weighted score is above average, which means that the Wal-Mart strategies are effective and the company is taking advantage of existing opportunities along with minimizing the potential adverse effects of external threats.

Differences between EFE and CPM

First of all, the CSFs in a CPM are broader; they do not include specific or factual data and even may focus on internal issues. The Critical Success Factors in a CPM also are not grouped into opportunities and threat as in EFE. In a CPM the ratings and total weighted scores for rival firms can be compared to the sample firm. This comparative analysis provides important insight which is missing in EFE.

Distinctive Competency/Compatibility and Core Competency and Competitive Advantage A company has a competitive advantage over its rivals when its profitability is greater than the average profitability for all companies in its industry. It has a sustained competitive advantage when it is able to maintain above average profitability over a number of years. The primary objective of strategy is to achieve a competitive advantage because then superior profitability will follow. Thus, strategy is the driver of competitive advantage and profitability.Distinctive competencies are firm specific strengths that allow a company to differentiate its products and/or achieve substantially lower costs than its rivals and thus gain a competitive advantage. Distinctive competence of a firm refers to a set of activities or capabilities that a company is able to perform better than its competitors and which gives it an advantage over them. Distinctive competence can lie in different area such as technology, marketing activities, or management capability. A company needs to develop its strategy that utilizes its distinctive competence to gain competitive advantage. It must be remembered that what distinctive competence of a firm may change with time as other companies develop new capabilities and with change in market requirements. Therefore companies need to identify their distinctive competence by careful analysis, and if required, strive to develop new competences to meet changing market requirements and competitive situation.The concept of distinctive competence was first put forward by Philip Sleznick in 1957. Kenneth R Andrews further elaborated it in 1971. Distinctive Competencies vary from one institution to another; examples include timely service delivery, convenient price schedule, flexible policies on service and goods, performance and reliability of a company. Company Distinctive Competencies are a set of unique competitive activities that an institution does to set it apart from other organisations. For example, Toyota has distinctive competencies in the development and operation of manufacturing processes. Toyota pioneered a whole range of manufacturing techniques, such as just in time inventory system, self managing teams, and reduced set up times for complex equipments. These competencies, collectively known as the Toyota lean production system, helped it to attain superior efficiency and product quality, which are the basis of its competitive advantage in the global automobile industry. The concept of distinctive competence is quite similar to the concept of core competence. While some authors consider these two term to mean the same thing, as per authors like C.K. Prahlad core competences must satisfy two additional criteria. One, it must be difficult to copy or replicate by competitors. Second, it should provide competitive advantage for multiple products and multiple markets.

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