Chapter 2: The environment and competitive forces

Chapter learning objectives

When you have completed this chapter you will be able to:

• apply the PESTEL model in a scenario
• apply Porter's diamond in a scenario
• describe what is meant by 'convergence' in industries
• evaluate an industry sector using Porter's five forces model
• analyse the influence of strategic groups
• evaluate business forecasting techniques used to assess the likely outcome of different business strategies
• using PESTEL, Porter's five forces and other suitable models, categorise environmental effects as opportunities or threats.

1 Introduction

If a strategic plan is going to have any chance of being useful, ithas to be based on gathering and analysing information. It is notpossible to plan by sitting in a darkened room, dreaming up scenariosthat have no connection to reality. This chapter describes some of theplanning tools that can help.

2 The PESTEL model

The PESTEL model looks at the macroenvironment, using the following headings:

• Political. The political environment includes taxation policy, government stability and foreign trade regulations.
• Economic. The economic environment includes interest rates, inflation, business cycles, unemployment, disposable income and energy availability and cost.
• Social. The social/cultural environment includes population demographics, social mobility, income distribution, lifestyle changes, attitudes to work and leisure, levels of education and consumerism.
• Technological. The technological environment is influenced by government spending on research, new discoveries and development, government and industry focus of technological effort, speed of technological transfer and rates of obsolescence.
• Ecological/environmental. The ecological environment, sometimes just referred to as 'the environment', considers ways in which the organisation can produce its goods or services with the minimum environmental damage.
• Legal. The legal environment covers influences such as taxation, employment law, monopoly legislation and environmental protection laws.

Overall, the model should allow a business to assess the growth prospects for the industry within which the organisation operates.

Further PESTEL examples

Social/cultural factors: include changes in tastes andlifestyles. They may also include changes in the demographic make-up of apopulation. For example in Western Europe people are living longer andin most countries the birth rate is falling, leading to an ageingpopulation. This has obvious implications for the types of products andservices which businesses and other organisations may plan to offer.Typical questions that need to be answered include:

• What are the current and emerging trends in lifestyles and fashion?
• What demographic trends will affect the size of the market or its sub-markets?
• Does the trend represent opportunities or threats?

Legal/political factors: the addition or removal oflegislative or regulatory constraints can pose major strategic threatsand opportunities. The organisation needs to know:

• What changes in regulations are possible and what will their impact be?
• What tax or other incentives are being developed that might affect strategy?

Economic factors: include interest rates and exchange rates,as well as the general state of the economy (e.g. entering or emergingfrom a recession). The organisation needs to know what the economicprospects and inflation rates are for the countries that it operates inand how will they affect strategy.

Technological factors: may include changes in retailingmethods (such as direct selling via the Internet), changes in productionmethods (greater use of automation), and greater integration betweenbuyers and suppliers via computer link-ups. The managers would need toknow to what extent the existing technologies are maturing and whattechnological developments or trends are affecting or could affect theindustry.

Environmental factors: include product stewardship, whichconsiders all raw materials, components and energy sources used in theproduct and how more environmentally friendly substitutes could be used.They also include ways in which product and product waste could be moreeffectively recycled. Typical questions that need to be answeredinclude:

• Are we adhering to the existing environmental legislation?
• Are there any new product opportunities that could be exploited that would have a favourable environmental impact on the market?
• What impact will future environmental legislation have?

Some of the PESTEL influences may affect every industry, butindustries will vary in how much they are affected. For example, aninterest rate rise is likely to affect a business selling cars (carpurchase can be postponed) more than it will affect a supermarket (foodpurchase cannot be postponed). More detailed analysis of the environmentand competitive forces will be focused on specific industries.

Illustration 1 – PESTEL for a newspaper

Illustration – The PESTEL model

A newspaper is planning for the next five years. The following would be some of the PESTEL factors it should consider:

• Political influences: tax on newspapers – many countries treat newspapers in the same way as books and have no sales tax (or value added tax) on their sales price. If government policies on the classification of newspapers were to change so that sales tax had to be charged, then sales of newspapers are likely to fall.
• Economic influences: exchange rates – most newspapers import their raw materials (paper, pulp etc.) and therefore they will suffer when their domestic currency weakens. Recession – in a recession buyers might move down market, so that cheap tabloids benefit, and more expensive broadsheets suffer. The opposite might apply as the economy recovers.    
• Social influences: people want more up-to-date information – buyers are less inclined to wait for news than they were 20/30 years ago and may therefore switch to alternative sources of information. More ethnicity in countries – the increased social mobility around the world might actually open new avenues of growth for newspapers through launching, for example, different language versions.
• Technological influences: there are many alternative sources of information that are provided through technologies such as the internet, mobile phones and television – this is likely to adverse affect the sales of newspapers. At the same time, e-readers are becoming more popular – this might present an opportunity for newspapers to provide daily downloadable content to these devices.
• Environmental/ecological influences: concern about the impact of carbon emissions from the use and production of paper – newspapers may be seen as being harmful to the environment due to their use of natural resources, their high production volumes and large distribution networks. Buyers might abandon newspapers in favour of carbon neutral news via modern technologies.
• Legal influences: limits on what can be published – this will make it harder for newspapers to differentiate themselves from each other and therefore harm growth prospects

Overall, it would appear that growth prospects for newspapers arepoor. The industry is more likely to decline than to grow. Existingrivals need to plan ahead for new products and new markets and perhapsfocus on new technologies such as the provision of news via e-readers.

Note that it does not matter under which category an influencehas been listed. Tax has economic, legal and political dimensions. Allthat matters is that tax has been considered in the environmental scan.

Test your understanding 1

Carry out a PESTEL analysis on a supermarket business. Try to get at least two items under each heading.

3 Porter's five forces model

Porter looked at the structure of industries. In particular,he was interested in assessing industry attractiveness, by which hemeant how easy it would be to make above average profits (forshareholders and to fund adequate investment). He concluded thatindustry attractiveness depends on five factors or forces:

Key point

Porter's five forces

Threat of new entrants

New entrants into a market will bring extra capacity and intensifycompetition. The threat from new entrants will depend upon the strengthof the barriers to entry and the likely response of existing competitorsto a new entrant. Barriers to entry are factors that make it difficultfor a new entrant to gain an initial foothold in a market. Major sourcesof barriers to entry are:

• Economies of scale, where the industry is one where unit costs decline significantly as volume increases, such that a new entrant will be unable to start on a comparable cost basis.
• Product differentiation, where established firms have good brand image and customer loyalty. The costs of overcoming this can be prohibitive.
• Capital requirements, where the industry requires a heavy initial investment (e.g. steel industry, rail transport).
• Switching costs, i.e. one-off costs in moving from one supplier to another (e.g. a garage chain switching car dealership).
• Access to distribution channels may be restricted (e.g. for some major toiletry brands in the UK 90% of sales go through 12 buying points, i.e. chemist multiples and major retailers). It is therefore difficult for a new toiletry product or manufacturer to gain shelf space.
• Cost advantages of existing producers, independent of economies of scale, e.g. patents, special knowledge, favourable access to suppliers, government subsidies.
• Know-how. It is much more difficult to penetrate a business where considerable know-how and skills are needed than to enter a simple, basic market.
• Regulation. Governments or professional bodies might supervise and limit new entrants.

Threat of substitute products

This threat is across industries (e.g. rail travel versus bustravel versus private car) or within an industry (e.g. long life milk asa substitute for delivered fresh milk). Porter explains that'substitutes limit the potential returns … by placing a ceiling on theprice which firms in the industry can profitably charge'. The betterthe price-performance alternative offeredby substitutes, the more readily will customers switch.

Bargaining power of customers

Powerful customers can force price cuts and/or qualityimprovements. Either way, margins are eroded. Bargaining power is highwhen a combination of factors arises.

Such factors could include where

• a buyer's purchases are a high proportion of the supplier's total business or represent a high proportion of total trade in that market
• a buyer makes a low profit
• the quality of purchases is unimportant or delivery timing is irrelevant, and prices will be forced down
• there are similar alternative products available from other suppliers.

Bargaining power of suppliers

The power of suppliers to charge higher prices will be influenced by the following:

• the degree to which switching costs apply and substitutes are available
• the presence of one or two dominant suppliers controlling prices
• the extent to which products offered have a uniqueness of brand, technical performance or design not available elsewhere.

Competition/rivalry

Intensity of existing competition will depend on the following factors:

• Number and relative strength of competitors. The competition in a market can range from perfect competition through to monopoly.
• Rate of growth. Where the market is expanding, competition is low key.
• Where high fixed costs are involved companies will cut prices to marginal cost levels to protect volume, and drive weaker competitors out of the market.
• If buyers can switch easily between suppliers the competition is keen.
• If the exit barrier (i.e. the cost incurred in leaving the market) is high, companies will hang on until forced out, thereby increasing competition and depressing profit.

Illustration 2 – Porter's five forces

Consider the attractiveness of the industry for a builder of commercial property:

Competitive rivalry

There are likely to be tens and perhaps hundreds of thousands of firms! But larger firms have some advantages

(1)Greater bargaining power when purchasing prime development sites

(2)Dealing with major customers

(3)Economies of scale (e.g. in using prefabrication building techniques)

(4)Pursuing planning applications

(5)Better able to offset risk

(6)Better able to use sophisticated techniques such as critical path analysis need for larger developments

(7)More able to offer part-exchange deals to house buyers

However, this must not be taken to extremes:

(1)The individuality of each construction project limits economies of scale – especially in respect to materials.

(2)It is difficult for firms to differentiate their product – basically make what the architect has designed.

(3)Even small firms can benefit from learning effects.

Overall, this is likely to be a highly competitive market where price wars and industry consolidation are common.

Threat of entry

There are likely to be low barriers to entry through low capitalrequirements (equipment can be hired if necessary) and a potential highlevel of available, skilled labour. Working capital may be an issue butprogress payments from buyers can be used to reduce this barrier. Thereare also likely to be few legal barriers as no formal qualificationsneeded.

It will therefore be important to build a brand and a reputation(for example, based on reliability, quality, workmanship and efficiency)to ensure that a buyer chooses an existing builder over a new rival.

Threat of substitutes

The main threat is second hand property available for rent orpurchase. There may be a lot of property available but high prices insome parts of the country might make new property more attractive.(However this will partly be offset by higher land prices in suchareas). But as governments continue to invest in regenerationinitiatives there should still be a demand for new buildings.

This factor is likely to be closely linked to the PESTEL model –for example, the threat will be highest when the economy is in decline,but it will be low when demand for housing is increasing.

Power of suppliers

There are likely to be numerous suppliers of materials selling anundifferentiated product. So suppliers should generally have low powerand large builders should be able to demand bulk discounts and toachieve cost control.

Power of customers

Commercial buyers will have low switching costs, the product isundifferentiated and buyers may themselves be experiencing lowprofitability. This is likely to make them powerful and allow them todemand lower prices for work done.

Overall opinion

It would appear that margins in this industry are likely to be low.It is very competitive and buyers have lots of power (and lots ofavailable substitutes). Commercial builders will have to rely on a highvolume of work and will need to establish a reputation that ensures thatbuyers choose them over rivals.

Test your understanding 2

Apply a five forces analysis to a company that does gardenmaintenance for households – cutting grass, removing weeds, pruningshrubs, etc.

4 Porter's diamond

Porter tried to answer the following questions:

• Why does a nation become the home base for successful international competitors in an industry? Germany is renowned for car manufacture; Japan is prominent in consumer electronics.
• Why are firms based in a particular nation able to create and sustain competitive advantage against the world's best competitors in a particular field?
• Why is one country often the home of so many of an industry's world leaders?

Porter called the answers to these questions thedeterminants of national competitive advantage. He suggested that thereare four main factors which determine national competitive advantage andexpressed them in the form of a diamond.

Further detail on Porter's diamond

(a) Favourable factor conditions:

Porter also found that countries with factordisadvantages were forced to innovate to overcome these problems, e.g.Japanese firms experienced high energy costs and were forced to developenergy efficient products and processes that were subsequently demandedworldwide.

(b) Demand conditions: there must be astrong home market demand for the product or service. This determineshow industries perceive and respond to buyer needs and creates thepressure to innovate. A compliant domestic market is a disadvantagebecause it does not force the industry to become innovative andexcellent.

(c) Relating and supportingindustries: the success of an industry can be due to its suppliers andrelated industries. Sweden's global superiority in its pulp and paperindustries is supported by a network of related industries includingpackaging, chemicals, wood-processing, conveyor systems and truckmanufacture. Many of these supporting industries have also achievedleading global positions.

(d) Firm strategy, structure andrivalry: organisational goals can be determined by ownership structure.Unquoted companies may have slightly longer time horizons to operate inbecause their financial performance is subject to much less scrutinythan quoted companies. They may also have different 'return on capital'requirements.

Porter found that domestic competition was vital as aspur to innovation and also enhanced global competitive advantage.Conversely, where governments have encouraged mergers to get thecritical mass required to be a global player, these national monopolieshave not, on the whole, been successful in establishing a globalposition.

Illustration 3 – Porter's diamond

Would a manufacturer of four-wheel-drive vehicles be likely to become world class if based in Scotland?

• Factor conditions: rugged wet terrain with harsh winters mean that four-wheel-drive vehicles are required.
• Demand conditions: many local people would certainly demand them and would be very discerning of differences in quality.
• Related and supporting conditions: the automotive components industry is not strong in Scotland.
• Firm strategy, structure and rivalry: not much rivalry, so no structural advantages.
• Although factor conditions provide the right environment and home demand would be strong, the other elements of the diamond are missing.

Test your understanding 3

Apply Porter's diamond to the US personal computer (PC) industry.

5 Industry convergence and strategic groups

Over time industries can converge together to form one, largerindustry (for example, mobile phones and PDAs have converged into thesmartphone industry). This can make environmental analysis much tougher.

Industry convergence

External, environmental analysis is becoming more complicated inthe real world as industries converge on one another. For example, tenyears ago we could have carried out separate PESTEL and 5 Forcesanalysis for the mobile phone industry, the mp3 industry, the cameraindustry, the hand-held gaming console industry etc. But today theseindustries have started to converge and many products (for example, theApple i-Phone) offer all the features that were once offered by separateproducts in different industries. This convergence is likely toincrease as technology advances and it means that companies will befacing greater levels of substitutes than they have in the past.

In June 2008, the examiner set a question requiring 5 Forcesanalysis of the mobile phone industry and it was important to highlightthat this would be hampered by industry convergence.

Definition:

• An industry is a group of firms selling the same principal product, or products which are close substitutes.
• A sector extends the idea of industry into the public services.

However, the boundaries of an industry or sector can change through the convergence of previously separate industries.

Convergence can be analysed in terms of whether it is supply led ordemand (market) led and also whether there is convergence insubstitutes or convergence in complements, e.g. products/services thatcomplement each other.

• Supply-led, where producers try to see connections between separate industries or sectors, e.g. supermarkets offering retail banking.
• Market-led, where buyers see or want connections between separate industries or sectors, e.g. customers in a book store also wanting to browse CDs and DVDs.
• Convergence in substitutes, where one technology can replace another, e.g. mobile phones and landline phones.
• Convergence in complements, where two technologies work better together, e.g. Panasonic (electronics) and Leica (lenses) producing digital cameras.

The four influences can be shown as a matrix:

But at the same time strategic groups might form within theindustry which focus on different niches and compete on a narrowerfocus. For example, some mobile phones will focus on their cameraability, others will focus on their music playing ability, etc. Theenvironmental analysis can then become a little more focused again.

Strategic groups

Strategic groups are organisations within an industry or sectorwith similar strategic characteristics, following similar strategies orcompeting on similar bases.

Strategic group analysis is a help to understanding the competitive structure of an industry:

• Against whom is an organisation directly competing?
• How possible, or likely, is it for an organisation to change strategic groups? A set of strategic groups generally includes a set of mobility barriers that inhibit or prevent organisations from moving to another group, e.g. low-cost production, brand names, low overheads or a local customer base.
• Identify potential opportunities and threats.
• Reduce the set of relevant competitors. Many industries contain many more competitors than can be analysed individually. Often it is simply not feasible to consider 30 competitors, to say nothing of hundreds. Reducing this set to a smaller number in a strategic group makes the analysis easier.

A strategic group could:

• have similar characteristics, e.g. size
• pursue similar competitive strategies over time e.g. heavy advertising and the use of the same distribution channel or
• have similar assets and skills, e.g. quality image.

The concept of strategic groups is important because one way todevelop a sustainable competitive advantage is to pursue a strategy thatis protected from competition by assets and skills that representbarriers to competitors. It also helps to gain a better understanding ofthe bases of rivalry within strategic groups and how it differs fromthat within other groups.

Strategic groupings can refine the strategic investment decision.Instead of determining in which industries to invest, the decision canfocus on what strategic group a firm should invest in. Thus, it will benecessary to determine the current profitability and future potentialprofitability of the strategic group. One strategic objective is toinvest in those strategic groups that will tend to be profitable overtime and to disinvest or avoid strategic groups that will not beprofitable.

Ultimately the selection of a strategy and its supporting assetsand skills will often mean selecting or creating a strategic group.

The concept of strategic groups can also be helpful in projectingcompetitive strategies into the future. One of the transformations thatwill influence the business models and the work of strategists in thedecades ahead is that the strategic space available to companies willexpand.

Consider, for example, the highly regulated power supply industry.All utilities once looked alike and their scope of operations wereconstrained by public utility commissions and government regulators.Owing to deregulation, utilities can now determine their own strategicspace. Today utilities have a choice regarding the level of verticalintegration: 'Do I need to be in power generation? Do I need to be inpower transmission?' Companies can 'unbundle' assets and can alsosegment their businesses: 'Should we focus more on industrial ordomestic consumers?' They can decide their geographical scope: 'Should Ibecome global, regional, national or just remain local?' And finally,they can change their business portfolio: 'Should I invest in water,telecommunications, gas lines, services?’

The forces of change – deregulation, the emergence of largedeveloping countries such as India, China and Brazil as major businessopportunities – provide a new playing field. Simultaneously, theforces of digital technologies, the emergence of the internet and theconvergence of technologies, provide untold new opportunities forstrategists. The canvas available to the strategist is large and new.

One of the problems with the strategic group model is that itimplies each group competes on the same critical success factors.Furthermore, it does not adequately capture strategies that attempt toplace an SBU in each strategic group while drawing out whateversynergies are possible. However, it is very useful for matching upgroups of customers to groups of competing companies.

Test your understanding 4

What strategic groups might exist in the morning newspaper business and how are they distinguished?

It may be that some of the companies within a particular strategicgroup might collaborate together to improve their overall competitive ormarket position.

How collaboration can bring advantages

This can be looked at in terms of Porter's five forces analysis.

• Buyer pressure. This can be reduced by forming close alliances with customers. For example, collaboration on design and research and development. Once successful alliances are made, customers will be relatively reluctant to switch to another supplier.
• Supplier pressure. For example, supermarkets form close collaborations with suppliers to manage their inventories.
• Threat of new entrants. Collaboration between existing rival companies can spread marketing and research costs more thinly, making it more difficult for new companies to enter the market.
• Substitute products. The issues here are the same as for new entrants. Many trade associations exist to allow collaboration on an industry-wide level, for example by lobbying.

Test your understanding 5

How could collaboration between rival chains of supermarkets be used to promote genetically modified food?

6 Quantitative techniques

The techniques covered so far have been 'qualitative methods'of forecasting what might happen to future volumes, costs, revenuesetc. They could be backed up by further qualitative techniques such asmarket research.

Businesses may also want to quantify these forecasts (for example,for budgeting, planning and evaluation purposes) and there are a numberof quantitative techniques with which you should be familiar such as linear regression and time series analysis.

In exam scenarios students must be able to discuss the suitability,principles and uses of these techniques, but students will not be askedto perform the mathematical calculations.

Linear regression

Regression is a simple statistical tool used to model thedependence of a variable (say, costs) on one (or more) explanatoryvariables (say, volume). This functional relationship may then beformally stated as an equation, with associated statistical values thatdescribe how well this equation fits the data.

Linear regression equation

Linear regression analysis can be used to make forecasts orestimates whenever a linear relationship is assumed between twovariables, and historical data is available for analysis.

Example relationships

Two such relationships are:

• A time series and trend line. Linear regression analysis is an alternative to calculating moving averages to establish a trend line from a time series. (Time series is explained later in this chapter)
  • The independent variable (x) in a time series is time.
  • The dependent variable (y) is sales, production volume or cost etc.
• Total costs, where costs consist of a combination of fixed costs and variable costs (for example, total overheads, or a semi-variable cost item). Linear regression analysis is an alternative to using the high-low method of cost behaviour analysis. It should be more accurate than the high-low method, because it is based on more items of historical data, not just a 'high' and a 'low' value.
  • The independent variable (x) in total cost analysis is the volume of activity.
  • The dependent variable (y) is total cost.
  • The value of a is the amount of fixed costs.
  • The value of b is the variable cost per unit of activity.

When a linear relationship is identified and quantified usinglinear regression analysis, values for a and b are obtained, and thesecan be used to make a forecast for the budget. For example:

• a sales budget or forecast can be prepared, or
• total costs (or total overhead costs) can be estimated, for the budgeted level of activity.

Correlation

Regression analysis attempts to find the relationship between anumber of variables. Correlation is concerned with establishing howstrong the relationship is.

Clearly in the first diagram, the regression line would be a muchmore useful predictor than the regression line in the second diagram.

Degrees of correlation

Two variables might be:

(a)perfectly correlated

(b)partly correlated

(c)uncorrelated

Different types of correlation explained

Perfect correlation

All the pairs of values lie on a straight line. There is an exact linear relationship between the two variables.

Partial correlation

In the first diagram there is not an exact relationship, but lowvalues of x tend to be associated with low values of y, and high valuesof x tend to be associated with high values of y.

In the second diagram again there is not an exact relationship, butlow values of x tend to be associated with high values of y and viceversa.

No correlation

The values of the two variables seem to be completely unconnected.

Positive and negative correlation

Correlation can be positive or negative.

Positive correlation means that high values of one variable areassociated with high values of the other and that low values of one areassociated with low values of the other.

Negative correlation means that low values of one variable are associated with high values of the other and vice versa.

The correlation coefficient

The degree of correlation can be measured by the Pearsoniancorrelation coefficient, r (also known as the product moment correlationcoefficient).

r must always be between –1 and +1.

If r = 1, there is perfect positive correlation
If r = 0, there is no correlation
If r = –1, there is perfect negative correlation

For other values of r, the meaning is not so clear. It is generallytaken that if r > 0.8, then there is strong positive correlation andif r < –0.8,="" there="" is="" strong="" negative="" correlation,="" however="" moremeaningful="" information="" can="" be="" gathered="" from="" calculating="" the="" coefficientof="" determination,="">².

The coefficient of determination

This measures how good the estimated regression equation is, designated as r²(read as r-squared). The higher the r-squared, the more confidence onecan have in the equation. Statistically, the coefficient ofdetermination represents the proportion of the total variation in the yvariable that is explained by the regression equation. It has the rangeof values between 0 and 1.

For example, if we read the following statement "factory overhead is a function of machine-hours with r²= 0.80," can be interpreted as "80% of the total variation of factoryoverhead is explained by the machine hours and the remaining 20% isaccounted for by something other than machine-hours." The 20% isreferred to as the error term.

Limitations of simple linear regression

(1)Assumes a linear relationship between the variables.

(2)Only measures the relationship between two variables. In reality the dependent variable is affected by many independentvariables.

(3)Only interpolated forecasts tend to be reliable. The equation should not be used for extrapolation.

(4)Regression assumes that the historical behaviour of the data continues into the foreseeable future.

(5)Interpolated predictions are only reliable if there is a significant correlation between the data.

Time series analysis

Time series forecasting methods are based on analysis of historical data. They make the assumption that past patternsin data, such as seasonality, can be used to forecast future datapoints. This means that it's future predictions are more curved thanlinear.  

Trends in data can lead to curves

For example, if a business knows that, over the last 5 years, month12 has seen volume levels that are 40% greater than typical monthlyvolumes, then it might be reasonable to forecast that month 12 for theforthcoming year will follow a similar pattern.

This should allow the predictions to take account of likely'curved' performance – for example, where we don't expect sales torise by a constant amount each period, but instead expect it to increaseand follow past trends where some periods are above the average and some periods are below the average.

This may be best seen in the following illustration:

In this scenario, linear regression has predicted an increase insales of £4m per quarter. It takes no account of any seasonality. Timeseries works on the same increase per quarter and reaches the same pointat the end of the period. But it has taken account of past trends whichsuggest that quarter 1 sales are usually £4m below trend, quarter 2'sare £4m above and quarter 3's are £4m below.

Be aware however that in time series analysis the trend line itself mayalso be curved – in fact, it would only be linear (as in thisexample) if the favourable and adverse seasonal affects cancel eachother out.

Components of times series analysis

Time series analysis has three basic components:

• average: the mean of the observations over time
• trend: a gradual increase or decrease in the average over time
• seasonal influence: predictable short-term cycling behaviour due to time of day, week, month, season, year, etc.

These components can be used in different ways to produce future forecasts.

Note: moving averages are used to identify the trend. In this waythe gradual change should become more obvious as figures are 'smoothed'out.

Other elements

The forecast data will also be affected by

• cyclical movement: unpredictable long-term cycling behaviour due to business cycle or product/service life cycle
• random error: remaining variation that cannot be explained by the other four components

Variations of time series analysis

There are two key variations of time series analysis:

(1)  moving averages: the forecast is based on an arithmeticaverage of a given number of past data points. This should make thetrend become more obvious.

(2)  exponential smoothing: a type of weighted movingaverage that allows inclusion of trends, etc. This gives greaterweighting to more recent data in order to reflect the more recent trend.

Example of a time series

Consider the following data set:

It is difficult to immediately spot the trend as the figures appear to be constantly increasing and decreasing.

But a moving average of this data (using 4 period averaging) would show:

It is now much easier to identify the gradual increase that isobserved in the average data. (Note that the increase isn't at aconstant rate so that this trend line would be slightly curved).

An exponential smoothing of the data would present a similar picture:

Calculations:

The first moving average is calculated as the average sales fromperiods 1 to 4. The second is the average from periods 2 to 5 etc.

The exponential smoothing uses the same periods. But the average iscalculated by taking 4 times the 4th period, 3 times the third period, 2times the 2nd period and 1 times the first period and then dividing by atotal of ten.

Advantages and disadvantages of time series analysis

Conclusions on quantitative techniques

Two different forecasting techniques have been explored here (andthere are many more in the real world). Linear regression is mostrelevant when there is a linear relationship between the variables, timeseries analysis is most appropriate when seasonal variations causescurved forecasts.

The reliability of a forecasting method can be established overtime. If forecasts turn out to be inaccurate, management might decidethat they are not worth producing, and that different methods offorecasting should be tried. On the other hand, if forecasts prove to bereasonably accurate, management are likely to continue with the sameforecasting method.

7 Environmental opportunities and threats

This chapter has looked at a number of tools (or models) that canbe used to help to make sense of the environment. The results of theseanalyses can be classified as either an:

• opportunity or a
• threat.

Once categorised as an opportunity or threat the influences first need to be:

• prioritised, e.g. some will be much more important than others.

Then the organisation has to decide how to:

• grab the best opportunities
• defend against the most serious threats.

There is absolutely no point in identifying opportunities and threats, but do nothing about them.

Explanation of opportunities and threats

Opportunities are favourable conditions that usually arisefrom the nature of changes in the external environment, e.g. newmarkets, improved economic factors or a failure of competitors.Opportunities provide the organisation with the potential to offer newor to develop existing products, facilities or services.

Threats are the opposite of opportunities and also arisefrom external developments. Examples include unfavourable changes inlegislation, the introduction of a radically new product by acompetitor, political or economic unrest, changing social conditions orthe actions of a pressure group.

For opportunities it is necessary to decide:

• What opportunities exist in the business environment?
• What is their inherent profit-making potential?
• Can the organisation exploit the worthwhile opportunities?
• What is the comparative capability profile of competitors?
• What is the company's comparative performance potential in this field of opportunity?

For threats it is necessary to decide:

• What threats might arise, to the company or its business environment?
• How will competitors be affected?
• How will the company be affected?

It may be a little simplistic to assume that blame can beapportioned exclusively to the organisation's environment when, in fact,weaknesses in (say) the management team or the organisational structuremay have led to a compounding of the problems arising externally.Indeed, throughout our analysis we must bear in mind the linkagesbetween issues and the possibility that it may have been a combinationof various internal and external factors that led to the problems beingexperienced.

Illustration of opportunities and threats

The following might represent some of the opportunities and threats identified for a commercial television station.

Many of these influences arise from PESTEL, but Porter's five forces and the other tools can be relevant also.

Remember, it doesn't matter which model is used to identify an influence. All that matters is that it has been identified.

Test your understanding 6

Perform an opportunities and threats analysis on:

(1)a passenger train service

(2)a nuclear power station.

8 Chapter summary

Test your understanding answers

Test your understanding 1

Here are our suggestions. You might have other valid ones.

Political influences: planning policy on large out-of-townsites,competition policy.

Economic influences: unemployment rate, interest rates, taxation.

Social influences: changes in population sizes, changes in consumertaste (for example, possibly more health conscious).

Technological influences: the internet (internet ordering),sophisticated Just-In-Time systems, food packaging technology.

Environmental/ecological influences: use of land for building,sustainable resources, packaging, animal welfare.

Legal influences: health and safety regulations, consumer legislation,food packaging regulations, inclusion of additives in food.

Test your understanding 2

A garden maintenance company

Threat of entry: high. Only modest amounts of capital and know-howareneeded. No regulations, hard to differentiate, and limited scope foreconomies of scale.

Threat of substitute products: low, except for householders who opt for avery low-maintenancegarden and for customers who choose to lookafter their own gardens.

Bargaining power of customers: low. There will be many smallcustomers so individual bargaining power will be low. Quality is perhapsnot a vital component of the service.

Bargaining power of suppliers: low. The supplies needed are widelyavailable.

Competition: high. The business is very easy to get into. There arenegligible switching costs.

Test your understanding 3

Factor conditions: large population of well-trainedengineers.

Demand conditions: large population of individuals and businesseswho need or want PCs.

Related and supporting industries: many component manufacturersclose by; large and well-endoweduniversities.

Firm strategy, structure and rivalry: an entrepreneurial economyallowed many startups and the best survive the intense rivalry.

Test your understanding 4

Possible strategic groups are:

• the tabloids which are relatively cheap. Lots of pictures. Not much serious reporting.
• the so-called ‘broadsheets’ (though many are now in tabloid format). More expensive. Large amounts of reporting and editorial compared to pictures.
• the free papers. Small, chatty, enough reading to entertain you on the journey to work. No heavy editorials. High number of advertisements.

Test your understanding 5

(a)Collaborative research into the effects of growing and consuming GM foods.

(b)Lobbying governments.

(c)Marketing – a united front.

(d)Simultaneous stocking of new foods.

Test your understanding 6

(1)A passenger train service

Threats

• losing the franchise or right to operate the service (if the service is provided by a private company)
• underinvestment in the network infrastructure
• terrorism
• increased affluence in some countries leading to less use of trains as people acquire cars
• competing services.

Opportunities

• increasing cost of petrol making cars more expensive to run
• environmental concerns and regulation
• building customer loyalty, e.g. perhaps a scheme similar to air miles
• innovative fares for different market segments
• new routes which are very expensive to develop but once established might be barriers to entry of competitors
• new technology, e.g. magnetic levitation; generally reduced journey times.

(2)A nuclear power station

Threats

• environmental concerns about the nuclear industry
• terrorism
• theft of nuclear material
• accidental release of radioactive material
• alternative energy sources (e.g. biotechnology might provide a very efficient way of creating fuel from sunlight)
• global warming, e.g. less fuel needed to heat homes and offices.

Opportunities

• political risks associated with reliance upon Middle Eastern and Russian supplies of fossil fuels
• environmental concerns about greenhouse gas emission from fossil fuel use
• global warming, e.g. more fuel needed to cool homes and offices
• growing world demand for power
• new technology to deal safely, and permanently, with radioactive waste.

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