Environmental Analysis
The first step of the strategic management process is environmental analysis. In essence, an organization can be successful only if it is appropriately matched to its environment. Environmental analysis is the study of the organizational environment to pinpoint environmental factors that can significantly influence organizational operations. Managers commonly perform environmental analyses to help them understand what is happening both inside and outside their organizations and to increase the probability that the organizational strategies they develop will appropriately reflect the organizational environment.
To perform an environmental analysis efficiently and effectively, a manager must thoroughly understand how organizational environments are structured. For purposes of environmental analysis, the environment of an organization is generally divided into three distinct levels: general environment, operating environment, and internal environment.9 Figure 7.2 illustrates the positions of these levels relative to one another and to the organization; it also shows the important components of each level. Managers must be well aware of these three environmental levels, understand how each level affects organizational performance, and then formulate organizational strategies in response to this understanding.
The General Environment
The level of an organization’s external environment that contains components having broad, long-term implications for managing the organization is the general environment. The components normally considered part of the general environment are economic, social, political, legal, and technological.
The Economic Component
The economic component is what indicates how resources are being distributed and used within the environment. This component is based on economics, the science that focuses on understanding how people of a particular community or nation produce, distribute, and use various goods and services. Important issues to consider in an economic analysis of an environment are generally the wages paid to labor, inflation, the taxes paid by labor and businesses, the cost of materials used in the production process, and the prices at which produced goods and services are sold to customers.
Figure 7.2 The organization, the levels of its environment, and the components of those levels
These economic issues can significantly influence the environment in which a company operates and the ease or difficulty the organization experiences in attempting to reach its objectives. For example, it should be somewhat easier for an organization to sell its products at higher prices if potential consumers in the environment are earning relatively high wages and paying relatively low taxes than if these same potential customers are earning relatively low wages and have significantly fewer after-tax dollars to spend.
Organizational strategy should reflect the economic issues in the organization’s environment. To continue with the preceding example, if the total amount of after-tax income that potential customers earn has significantly declined, an appropriate organizational strategy might be to lower the price of goods or services to make them more affordable. Such a strategy should be evaluated carefully, however, because it could have a serious impact on organizational profits.
The Social Component
The social component is the part of the general environment that describes the characteristics of the society in which the organization functions. Two important features of a society that are commonly studied during environmental analysis are demographics and social values.10
Demographics are the statistical characteristics of a population. These characteristics include changes in numbers of people and income distributions among various population segments. Such changes can influence how eagerly goods and services are received within the organization’s environment and thus should be reflected in organizational strategy.
For example, the demand for retirement housing would probably increase dramatically if both the number and the income of retirees in a particular market area doubled.11 Effective organizational strategy would include a mechanism for dealing with such a probable increase in demand within the organization’s environment.
An understanding of demographics is also helpful for developing a strategy aimed at recruiting new employees to fill certain positions within an organization. Knowing that only a small number of people have a certain type of educational background, for example, would tell an organization that it should compete more intensely to attract people with this educational background. To formulate a recruitment strategy, managers need a thorough awareness of the demographics of the groups from which employees eventually will be hired. This practice, known as strategic workforce planning, or SWP, helps organizations identify the workforce they need to achieve their strategic goals. Some early adopters of SWP, such as 3M, are able not only to track their workforce spending and determine how it impacts revenues but also to compare their data to those of competitors. The recent global economic downturn stalled the use of SWP, however. In attempting to “ride out” the recession, many employers adopted a “wait and see” attitude toward workforce planning until business stabilized.12
In the US, the percentage of under-25 workers is expected to fall, while the share of older workers rises. This could affect how companies plan to grow—for example, how they fill entry-level jobs.
Andres Rodriguez/Fotolia
Social values are the relative degrees of worth that a society places on the ways in which it exists and functions. Over time, social values can change dramatically, causing significant changes in how people live. These changes alter the organizational environment and, as a result, have an impact on organizational strategy. It is important for managers to remember that although changes in the values of a particular society may occur slowly or quickly, they are inevitable.
The Political Component
The political component is that part of the general environment related to government affairs. Examples include the type of government in existence, government’s attitude toward various industries, lobbying efforts by interest groups, the status of the passage of laws, and political party platforms and candidates. The recent shift of China’s political leaders from ignoring to now monitoring and improving air quality illustrates how the political component of an organization’s general environment can change at the international level.13
The Legal Component
The legal component is that part of the general environment that contains passed legislation. This component comprises the rules or laws that society’s members must follow. Some examples of legislation that specifically aims at the operation of organizations are the Clean Air Act, which focuses on minimizing air pollution; the Occupational Safety and Health Act, which aims at ensuring a safe workplace; the Affordable Care Act, which provides all Americans with access to affordable health care; and the Consumer Products Safety Act, which upholds the principle that businesses must provide safe products for consumers. Over time, new laws are passed and some old laws are amended or eliminated.
The Technology Component
The technology component is the part of the general environment that includes new approaches to producing goods and services. These approaches can be new procedures as well as new equipment. The trend toward exploiting robots to improve productivity is an example of the technology component. The increasing use of robots in the next decade should vastly improve the efficiency of U.S. industry.
The International Component
The international component is the operating environment segment that is composed of all the factors relating to the international implications of organizational operations. Although not all organizations must deal with international issues, the number that have to do so is increasing dramatically and continuously in the twenty-first century. Factors in the international component include other countries’ laws, cultures, economics, and politics.14 Important variables within each of these four categories are presented in Table 7.2.
Table 7.2 Important Aspects of the International Component of an Organization’s Operating Environment
| Legal Environment | Cultural Environment |
|---|---|
| Legal tradition | Customs, norms, values, beliefs |
| Effectiveness of legal system | Language |
| Treaties with foreign nations | Attitudes |
| Patent and trademark laws | Motivations |
| Laws affecting business firms | Social institutions |
| Status symbols | |
| Economic Environment | Religious beliefs |
| Level of economic development | |
| Population | Political System |
| Gross national product | Form of government |
| Per capita income | Political ideology |
| Literacy level | Stability of government |
| Social infrastructure | Strength of opposition parties and groups |
| Natural resources | Social unrest |
| Climate | Political strife and insurgency |
| Membership in regional economic blocs (EEC, LAFTA, etc.) | Government attitude toward foreign firms |
| Monetary and fiscal policies | Foreign policy |
| Nature of competition | |
| Currency convertibility | |
| Inflation | |
| Taxation system | |
| Interest rates | |
| Wage and salary levels |
U.S.-based Hershey’s recent acquisition of Chinese candy maker Shanghai Golden Monkey provides an example of the importance of the company’s international component. Before the acquisition, Hershey opened a research facility in Shanghai to develop candy and snacks that would appeal to Chinese consumers. Traditionally, Hershey has avoided large acquisitions, but this deal helps it focus on its primary international market, China, where candy consumption has increased nearly 40 percent over the past five years.15
The Industry Environment
The level of an organization’s external environment that contains components normally having relatively specific and immediate implications for managing the organization is the industry environment. The Five Forces Model, perhaps the best-known tool for industry analysis, was developed by internationally acclaimed strategic management expert Michael E. Porter.16 Essentially, Porter’s Model outlines the primary forces that determine competitiveness within an industry and illustrates how those forces are related.
Porter’s Model is presented in Figure 7.3. According to the model, the attractiveness of an industry is determined by five alternative forces. First, the threat of new entrants refers to the ability of new firms to enter an industry; as the threat of new entrants increases, the attractiveness of the industry decreases. Second, buyer power refers to the power that customers have over the firms operating in an industry; as buyer power increases, the attractiveness of the industry decreases. Third, supplier power denotes the power that suppliers have over the firms operating in an industry. As supplier power increases, industry attractiveness decreases. Fourth, the threat of substitute products refers to the extent to which customers use products or services from another industry instead of the focal industry. As the threat of substitutes increases, which implies that customers have more choices, the attractiveness of the industry decreases. Finally, intensity of rivalry refers to the intensity of competition among the organizations in an industry. As the intensity of rivalry increases, the attractiveness of the industry decreases.
Figure 7.3 Porter’s Five Forces Model, which determines competitiveness within an industry
The Internal Environment
The level of an organization’s environment that exists inside the organization and normally has immediate and specific implications for managing the organization is the internal environment. In broad terms, the internal environment includes marketing, finance, and accounting. From a more specific management viewpoint, it includes planning, organizing, influencing, and controlling within the organization.