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Business strategy
Introduction
Learning objectives
Explain how a business collects and distributes environmental information in order to manage its strategy Analyse for a given situation the external factors which may impact on a business's performance and identify significant issues in the following areas: Sustainable development Global macroeconomic forces International trade and financial systems Government policies Cultural environment
Tick off
Practical significance
The wealth of many European countries, and of the businesses within them, can be attributed to their early industrialisation and imperialism commencing in the 17th century. The USA caught up and overtook Europe during the early 20th century. From the mid 20th century those gains have been gradually superseded by the development of emerging economies in Asia and Latin America. These have brought new markets and new challenges which must be addressed by businesses from the developed economies if they are to survive.
Working context
Many of your clients will be global businesses, or at least have some form of buying and selling relationship with overseas firms. Your firm may be required to: Assist in transnational audits alongside professional colleagues from outside of your home country Assess the extra risks the client runs as a consequence of operating internationally Advise on taking-on international contracts
Syllabus links
Environmental analysis was covered in your Business and Finance paper under section 6 of the syllabus. However its coverage was at the level of core knowledge. In the Business Strategy examination you will be required to apply it.
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Examination context
Exam requirements
The scenarios in the majority of exam questions will require you to absorb and understand information about the external environment in which an organisation operates. You will also need to assess the implications of the environment and changes in the environment for the strategic positioning and strategic decisions of an organisation. To do this you will need to apply your knowledge of the tools and ideas covered in this chapter.
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Business strategy
1.1
To be viable (e.g. able to sustain itself through time) the organisation must achieve an appropriate 'fit' with this environment. This includes: Results that meet the expectations of its owners (shareholders, government, members etc) Products and services that meet its clients' expectations at least as well as rivals' Ability to remain within the legal and ethical codes of the societies it works in Attractive as a place to work for its staff Satisfying the needs of other powerful or influential stakeholders
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EXTERNAL ANALYSIS
INTERNAL ANALYSIS
CORPORATE APPRAISAL MISSION AND OBJECTIVES REVIEW AND CONTROL STRATEGIC ANALYSIS
GAP
Rational planning approach: Environmental appraisal is a one-off assessment which establishes the forces acting on the business at present and forecasts how these may develop during the years of the plan. Strategic management approach: The need for environmental scanning. This is a continuous awareness by management of environmental issues enabling them to be routinely considered in decision making.
(b) How do these main environmental/external factors affect the strategies of the practice? (c) In your view, how do managers perceive the environment of the organisation?
(d) How do you think managers incorporate environmental/external issues into decision-making? See Answer at the end of this chapter.
1.2
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Business strategy
1.2.1
External sources include: Trade media: The magazines and journals specific to the industry or to particular business functions Published accounts of rivals, suppliers and clients Government statistical reports On-line resources: Subscriptions to business information vendors, current awareness services (emails from vendors who monitor the media for articles containing keywords specified by management) Market reports: Published research from investment analysts, market researchers, trade departments of governments etc.
1.2.2
Issues to consider in validating environmental information include: Integrity of the source: internet gossip and market rumours lack integrity on their own Forecasting and predictive record in the past Degree of substantiation: is there more than one report or instance of this from independent sources? Age of the information: how up to date is it? Motivation of provider: does the provider have something to gain from convincing the firm of this information?
1.2.3
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2 Environmental dynamics
Section overview
The ability of the business to plan, and its requirement for environmental information, will be influenced by how predictable its environment is. In Business Strategy the factors affecting this are given very precise meanings.
2.1
Definition
Turbulence: How changeable the environment is and how easy it is to predict.
Lynch (Corporate Strategy) presents turbulence as Changeability Predictability Changeability Is the environment likely to change? There are two aspects to changeability. Complexity: The variety of influences and conditions. These include regulatory, social and political factors, technological change and internationalisation. Novelty: The degree to which the environment presents new situations to be dealt with.
Predictability Is it possible to forecast trends in the environment or at least make sensible predictions of discontinuous change? Again there are two aspects: Rate of change: In relation to the firm's ability to respond (slow to fast) to this (in other words, does the environment change at a slower pace than the organisation's ability to respond to it?) 'Visibility of the future': Is there reliable information to make forecasts for decision making?
The degree of turbulence will affect the amount of resources devoted to environmental assessment. For example, investment banks employ substantial research departments and each day begins with dissemination of relevant environmental information to traders and managers. Airlines also have research departments which 'red flag' issues on a regular basis and also provide reports and forecasts as inputs into their strategic planning process.
2.2
Scenario planning
Definition
Scenario planning: The development of pictures of potential futures for the purposes of managerial learning and the development of strategic responses.
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Business strategy
2.2.1
Introduction
Scenario planning is useful where a long-term view of strategy is needed and where there are a few key factors influencing the success of the strategy, e.g. in the oil industry there may be a need to form a view of the business environment up to 25 years ahead, and issues such as crude oil availability, price and economic conditions are critical. For example, Shell was the only major oil company to have prepared its management for dealing with the shock of the 1970s oil crisis through scenario planning and was able to respond faster than its competitors. Precision is not possible, but it is important to develop a view of the future against which to evaluate and evolve strategies. Scenario building attempts to create possible future situations using the key factors. The aim is to produce a limited number of scenarios so that strategies can be examined against them in terms of 'what if ...?' and 'what is the effect of ...?' (basically a form of sensitivity analysis). A car manufacturer could assess the impact of a 'Green Scenario' or a 'High Value Sterling Scenario' on its business. Financial models of the firm are often used in conjunction with this approach to assess impact on profit. Although these provide a useful approach, it is important not to become too committed to one scenario; after all, they are only forecasts which might not in the event be valid.
2.2.2
Steps
Identify key forces, using techniques such as PEST analysis (see later) Understand the historic trend in respect of the key forces Build future scenarios, e.g. optimistic, pessimistic and most likely.
The scenarios generated are then 'plots' to be played out making managers consider future possibilities and encouraging them to think about strategy more flexibly.
Identify the factors that make scenario planning popular with oil industries.
(b) Suggest some alternative scenarios that an oil producer might consider in its strategic planning.
3 PESTEL analysis
Section overview
In your Business and Finance paper, you will have encountered PESTEL factors in your studies of the environment of business. This section looks in each PESTEL factor in more detail and identifies how each may impact on the strategy of the organisation. Later sections extend analysis to the global business environment.
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3.1
Economic factors Globalisation Business cycles Interest rates Inflation Unemployment Exchange rates Environmental factors Sustainability issues, eg energy, natural resources Pollution, etc Green issues, etc
Technology Government and EU investment and R&D policy New discoveries: products and methods of production Speed of technology transfer Levels of R&D spending by competitors Developments in other industries that could transfer across
PEST ANALYSIS
Social/demographic factors Income distribution Social mobility Levels of education/health Size of population Location Age distribution Lifestyle changes Consumerism Attitudes to work and leisure Green issues, etc
Economic factors Globalisation Business cycles Interest rates Inflation Unemployment Exchange rates Environmental factors Sustainability issues, eg energy, natural resources Pollution, etc Green issues, etc
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Business strategy
3.2
Political factors
Political factors relate to the distribution of power locally, nationally and internationally. Political risk is the possibility that political factors will have an impact on the business's environment or prospects. The impact could be positive or negative, the issue is the uncertainty created. Types of risk include the following. Ownership risk: A company or its assets might be expropriated (or nationalised) by the state, normally with compensation. Confiscation is, effectively, expropriation without compensation. Operating risk: Indigenisation/domestication. The firm may be required to take local partners. There may be a guaranteed minimum shareholding for local investors. Transfer risk may affect the company's ability to transfer funds or repatriate profits. Political risk: The government of the host country may change taxes or seek a stake in the business to increase its power or to satisfy local public opinion.
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Sources of political risk Source The country This covers government stability, international relations, the ideology of the government in power, the need for contacts, favouritism for local suppliers, political violence, governments' ability to change the law and operating conditions, governments' need to appease powerful stakeholders. Consumer/basic products. High-tech components may have national security or armaments implications. Oil extraction in some countries places the oil companies near regions of ethnic or political conflict. Size, connections, reputation, influence on the environment.
The product
The company
Managing political risk Companies, especially transnational corporations, might take measures to reduce political risk. These include: Detailed risks assessments prior to investing in the country Seeking protection from legal agreements with the host country or from bi-lateral trade agreements between nations Partnering with a local business to increase acceptance of the project and to lobby for political support Raising finance for projects from host country to put local pressure on politicians to help safeguard investment Operate under the auspices of international bodies e.g. World Health Organisation, UNICEF etc. Share project with other firms to spread the risks between them Avoid total reliance on one country e.g. oil companies extract oil from many countries to offset risks of interrupted supplies or spiralling costs Lobbying for political support from home government for projects and to resolve issues Support for political groups in host country that are favourable to the project
3.3
Economic factors
A typical economic factor that should be considered in strategic decision-making is the economic structure of a country. Countries typically progress from reliance on primary industries (e.g. agriculture, minerals, forestry) through manufacturing to tertiary services (e.g. financial and commercial sectors). Lesser developed countries Reliant on a small number of products (e.g. crops or minerals) as the main export earner. Infrastructure is poor. Implications: Wealth and foreign exchange rate depend on yield of product and world price of product. Political actions aimed at securing control over incomes from product either domestically (e.g. insurgent liberation forces) or externally (e.g. develop cartels, invasion etc). Newly industrialising countries Rapid industrialisation and manufacturing base grows Implications: Infrastructure struggles to keep pace (e.g. power shortages, lack of housing, lack of roads, ports etc). Large shifts in population towards areas of industry and away from villages. Advanced industrial country There is a wide industrial base and a well developed service sector.
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Growth rate %
Recovery
Boom
Recession
+ 0 Depression
The long-term trend of industrialised economies is one of positive growth. The different phases of the cycle have the following characteristics: Recovery phase Increased business confidence and investment causes growth to increase. Unemployment declines and consumer confidence/spending rises. Boom phase Growth exceeds the long-term trend. Demand is too great, leading to rising prices of goods, balance of trade deficits (as exports fall, imports rise), labour shortages and wage/factory price increases. Recession phase Demand falls, leading to increased unemployment and falling investment and business/consumer confidence. Recession is often first seen in building and capital goods sectors. Depression phase Weak consumer and business spending/confidence. Unemployment in excess of normal levels with falling (or even negative) inflation and wage cuts. In setting strategy an organisation needs to consider where the economy is currently and where it is heading. Long-term exchange rates' behaviour affect the relative competitiveness of imported and domestically produced products and exports. A falling domestic exchange rate makes firm's exports more competitive and imported inputs more expensive. This may be determined by the value of key exports such as oil, minerals, crops, manufactured goods etc. Interest rates (long-term and short-term) affect cost of finance and also levels of demand in the economy. The economic infrastructure, for example access to payments systems, consumer and trade credit, access to venture and other capital, the quality of the stock exchanges.
3.4
Social/cultural factors
These factors affect strategy in several ways: They affect the market for products, e.g. religious proscriptions on food, financial services They affect promotional strategies, e.g. language of adverts, considerations of imagery and decency They affect methods of conducting business in countries, e.g. conventions of negotiation, giving and receiving of gifts, ensuring 'face' for contacts (i.e. maintaining self-respect and status) They affect methods of managing staff, e.g. language differences, attitudes to managerial authority They affect expectations of business conduct, e.g. extent of engagement with CSR, time horizon of investment, engagement in political matters.
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Social factors include Make-up of population: e.g. growth rate, proportion of old and young people Family structure and size; the importance (or lack of it) of the extended family and relationships with non family members; the extended family provides contacts and work. The role of women in the labour force and in society as a whole (expectations vary from society to society). In different cultures, gender stereotypes are more sharply drawn than in the industrialised west. Extent of social mobility: the degree of social stratification and difference within each society and whether people can move between them, the changes in size, wealth and/or status of different groups within the population and the geographical distribution of the population between regions and urban, suburban and rural areas.
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Business strategy was at the centre of Europe's wealthiest region, and the French government offered inducements. Despite opposition from French intellectuals, the project went ahead. Disney owned 49 percent of the shares. The project plans assumed there would be a large number of visitors who would want to stay in the vicinity of the park. The park opened on 12 April 1992. However, queues formed for rides that did not work and 'many of the employees appeared to be struggling with the need to conform to Walt Disney's code of acceptable behaviour'. (Curwen, 1995) Curwen (1995) identified a number of difficulties, which we have listed below. Some were bad luck and some were of Disney's own making. In 1992, when the park opened, mainland Europe was entering a recession. The value of the French franc rose, increasing the costs to Italian and British holidaymakers. (The UK left the exchange rate mechanism in 1992, and Italy was temporarily suspended). The weather EuroDisney should have considered this factor. Paris is in northern Europe. Why should holidaymakers go to a rain-drenched version of a Disney theme park when they could experience the 'real thing' in sunny Florida (or California)? A trip to EuroDisney would rarely provide more than a couple of days' outing: hence attendance figures were optimistic. Hotel occupancy rates were low (in part because of the excellent transport facilities to Paris). Admission charges were seen as too high, and visitors 'broke the rules' by smuggling in their own food and drink. Price resistance was a key issue. Labour turnover was very high. French employees did not behave like Americans.
Cultural issues Alcohol, as in the US theme parks, was banned. This impacted on the traditional French Sunday Lunch which is relaxed, conversational and where wine is served. Thus the full service restaurants saw reduced trade. The management team were American, there were no European representatives. At one point the French media called it a 'Cultural Chernobyl'.
The first year was catastrophic. The Disney corporation reconsidered its plans for further expansion of the site. However, the French government, the bankers and Disney itself had good reasons for business to continue, and were able to persuade a wealthy Saudi investor to contribute. Recovery After this disastrous start, the company began to turn around, and it reported a profit in 1995. As well as financial support from a Saudi investor, and Disney's agreement to forego royalties the company began to change. Pierre Bourguignon, the CEO, also attempted to institute cultural and structural change, and to change the marketing. The chain of command with reduced employees were empowered to take decisions. There were 220 small groups with total profit responsibility. All managers have to work on the front line once a week. Admission prices were cut by 20 percent and cost of staying in the cheaper hotels was cut. The catering was improved, with lower prices, more fast food, drinks and so on.
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Cultural issues Reflecting greater sensitivity to national factors, EuroDisney targeted its marketing and promotional offers more closely to those factors.
The 'low-price' marketing strategy did not conform with the USA's strategy of offering a 'premium' quality product, but the strategy brought in more people. However, attracting people to the more expensive hotels has been difficult. By 1996 EuroDisney, by then renamed Disneyland Resort Paris, had become France's most-visited tourist attraction. Management embarked on an ambitious expansion scheme opening Walt Disney Studios in 2002. Hong Kong In 2005 Disney opened its fifth, and smallest, Disney park on reclaimed land in Hong Kong. Disney owns 43% and the Hong Kong government 57%. Initial cultural adaptation problems included: Significant overcrowding at Chinese New Year as a an unanticipated wave of visitors arrived from mainland China Protests from global environmental groups at the inclusion of shark's fin soup on the wedding menus at Disneyland HK Criticisms from guests of wait times and overcrowding which had been endured more quietly at other Disney resorts Guests not respecting no-smoking and alcohol-free regulations.
In May 2007 it was reported that declining attendances at Disneyland HK and revenues below targets were jeopardising Disney's ability to raise finance to continue the planned investments in the resort. Management was contemplating significant promotional activity to turn it around.
3.5
Technology
Technological differences and change operate at three levels: 1. 2. 3. Apparatus, technique and organisation: How technology is used in the business, e.g. the use of ICT within the firm . Invention and innovation: These affect the products being offered, e.g. the impact of higher power handsets on the development from mobile phone handsets to Personal Digital Assistants. Metatechnology: A technology that can have a variety of applications, e.g. lasers are a technology that have found uses in industry (welding), surgery (corrective eye surgery, key hole surgery), recorded music and software (CD, CD-ROM and DVD), and visual displays and light shows.
The strategic significance of the technological environment includes: Technological base, and therefore customer and staff familiarity with it, varies across countries. Operations will have to take this into account. Technological change challenges existing industry structure and competitive advantages and so strategies to harness or evade it are necessary. Technological change can render existing products obsolete. Therefore continuous R&D and learning is necessary to remain competitive. Technological change creates uncertainty which may influence the approach to strategy formulation that is adopted.
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Business strategy
As they thrash around for new direction, the pulp-and-paper giants of America and Europe must also deal with the forces of globalisation. Brazil, with fast-growing eucalyptus trees, is the cheapest place to make paper and China has recently gone from being a net importer to being a net exporter of newsprint. At the same time, emerging economies also represent new markets that are not as hooked on email as the developed world. However BlackBerrys and Dells will not keep a low profile in Brazil for ever. Source: Economist March 2007
3.6
Various socio-political consequences have been forecast. Much greater cross-national cooperation to combat this common threat. Re-mergence of state-funded nuclear energy as a solution following its international abandonment after the Chernobyl explosion in 1986 and the consequent escalating costs of safety. Political conflicts are breaking out between developed countries and emerging economies over carbon emissions. Inter-racial conflict and rise of fascism as populations migrate towards higher or more temperate climates and are rejected by indigenous people.
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Land grab wars between USA, China and European states over Siberia and Alaska. Increasing blame heaped on industrialised nations by impoverished states leading to calls for aid or other countries using and to gain political influence. Breakdown in civil order as population squabbles over diminishing food and water supplies.
Main government policies are: Reduce carbon emissions through targets set in cross governmental accords such as Kyoto agreements. Penalisation of carbon creating industries through taxes levied on emissions or on fossil fuels used. Investment in non-carbon creating technologies such as nuclear energy, wind and wave power and electric or hybrid cars. Making foreign aid dependent on acceptance of environmental policies by recipient countries.
Other ecological issues Energy gap as fossil fuels diminish at a time when India and China are growing rapidly and demand more energy. Waste recycling issues as developed countries recognise the forecast use of landfill and also realise that much landfill is hazardous waste (e.g. NiCad batteries, electronic circuitry, oil and solvents in car engines). Bio-diversity issues as growing of cash crops and destruction of forests for grazing or building land also destroys species of plant, insects and animals. Introduction of genetically modified organisms into the food chain leading to loss of species and potentially hazardous future effects.
Implications for business strategy Need to accept 'polluter pays' costs taxes on emissions and requirements that firms buy certificates from refuse firms confirming recovery or destruction of materials the firm introduces into the supply chain Increased emphasis on businesses acceptance of CSR and of principles of sustainable development; Potential for economic gain from cleaning-up operations and selling surplus 'permits to pollute' to firms that have not cleaned up Potential competitive advantage from development of products that ecologically conscious buyers will favour Need to monitor ecology-related geo-political and legislative developments closely
3.7
Legal factors
Legal factors relate to the role of law in society and its role in business relationships. This can be assessed in terms of: Systemic factors: How effective is the legal system at enforcing contracts? To what extent are legal decisions likely to be interfered with by politicians i.e. are the courts independent of government? How easy is it to get hold of legal advice? How speedy are the courts? To what extent is regulation delegated? Are rights of private property genuinely enforceable? Cultural factors: To what extent are business relationships conducted formally or informally? The USA is regarded as a litigious society; in Japan (partly because the small size of the legal profession), business is widely believed to be based more on long-term relationships. Context and regulatory factors: cover civil and criminal law, laws relating to consumer protection and advertising, employment and so forth. Furthermore, to what extent is competition promoted, regulated and enforced? Intellectual property rights are examples of specific issues which need to be considered.
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Business strategy
On 12 June 1993 The London-based newspaper The Sun dropped its cover price from 25p to 20p, claiming that this would help its readers in the recession. The Daily Mirror responded quickly, cutting its price for a single day to 10p, in an attempt to maintain circulation at the expense of lost revenue. The resulting increased circulation of The Sun was no surprise for the tabloid market. However, how would the circulation of the quality papers be affected by a similar strategy? It has always been felt that broadsheets are price insensitive and therefore that a similar strategy adopted by a broadsheet publication would be of no benefit: branding was too strong. However, Peter Stothard, editor of The Times, had begun to disagree, feeling that readers did have brand loyalty but were also very much interested in value for money. A drop in price, he felt, could enhance a publication's value for money and therefore on 6 September 1993 the price of The Times dropped from 45p to 30p. Media analysts were unconvinced, maintaining that any resulting increased circulation would not offset the decreased revenue, hence losses are the obvious result: CU200,000 for The Times and CU700,000 for The Sun per week (estimated). Analysts struggled to work out the rationale behind increased circulation bids. One justification was that it was needed to combat the overall decline in the newspaper market a 20% fall over the previous thirty years according to leading accountants. The worst affected by this decline had been the tabloids. Another argument was that it was done in order to affect Mirror Group Newspapers adversely during the sale of 55% of its shares in September. Whatever the reason, the worry was that the price of The Sun would rise again and when it did the success or failure of the strategy would be shown by how many of the new readers (300,000) were retained. As the tabloid market is price sensitive, the signs were not good. The outlook for The Times was slightly different: city analysts felt that a cut in price was necessary as the paper was on a downward spiral, having lost its previous image. The price cut, they felt, was there to stay: it was envisaged that more money would flow in from advertisers due to increased circulation. Advertising was a major concern for newspapers in the recession: a typical tabloid received 20% of its revenues from circulation, with the rest coming from advertising. Broadsheets, on the other hand, had a 50:50 split. The total split on advertising spend had changed dramatically in the previous decade. Newspapers Television Radio 1981 66% 20% 14% 1993 51% 36% 13%
The initial reaction to this was to increase newspaper prices but obviously this had limited effect, hence the cuts by News International. Rupert Murdoch, it was felt, could sustain initial losses from profits elsewhere: his competitors would not be able to do so. In 1993 The Daily Telegraph remained number one in the UK broadsheet market, its revenue declining by only 1% compared with the previous year. This was achieved by a series of promotions including discounted holidays, as well as by its readers showing remarkable loyalty and an unwillingness to move. The circulation of The Guardian had fallen by 5.6% and its market position had been affected as The Times overtook it in the race for second position. However, the paper still remained popular. The Independent, however, had been hardest hit. It was felt that the strategy of The Times could potentially squeeze it out of the market. If this were to be the result The Times was sure to benefit. The situation appeared to be mirroring the experience of the London Daily News a few years previously when it was driven out of business by the Evening News. Indeed, The Times would benefit both from increased circulation and increased advertising revenue if The Independent were to be terminated. However, The Independent was struggling before The Times cut its price. Its circulation had declined significantly since 1988 (20%) and it had been perceived as being 'weak' due to the lack of colour photographs. Although this was corrected it meant that the price of The Independent had to be increased to
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compensate. This 5p rise was unfortunate, since it was implemented a matter of weeks after the reduction by The Times. The Independent panicked and contacted the Office of Fair Trading, claiming that the price cut by The Times amounted to predatory pricing and that this was not allowed. This complaint was not upheld: it would have to be proved that the cut was aimed solely at The Independent and this would have been difficult to establish. Furthermore, The Independent was not one of the financially strongest companies, having made a loss approaching CU500,000 in the previous year. A takeover appeared to be a logical next step as The Independent did have a small niche in the market. However, whoever bought it would have to overcome the recent batterings which had left it with an image problem. If newspapers had been allowed to expand into TV, then the competitive picture would have changed completely. Requirement Discuss the environmental factors that affected the newspaper industry, using the following headings. (a) Political and Economic
4.1
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Business strategy This leads management to make significant strategic investment decisions that rely on assessments of the stability and trends of the global business environment: Development of products for international markets Advancing credit to clients in international markets or investing in businesses and assets in host countries Reliance of international sources for supplies of crucial inputs
4.2
Levitt (The Globalisation of Markets 1983) described the development of a 'global village' in which consumers around the world would have the same needs and attitudes and use the same products. A global corporation would be one that operated as if the entire world was one entity, to be sold the same things everywhere.
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Levitt's focus was on the marketing aspects of globalisation. The global business corporation will also be characterised by Extended supply chains: Instead of making the product at home and exporting it, or setting up a factory in the host country to make it, the global corporation may factor out production so that different parts of the product (or service) originate in different countries. Womack et al (The Machine That Changed The World) suggest that the globalisation of the automobile industry led the way for this model. Global human resource management: This involves pan-national recruitment and development of human resources. [Difficulty level: Easy]
Some would say that such purely global organisations are rare. Industry structures change and foreign markets are culturally diverse. Even within the USA, there is an enormous variety of cultural differences. Can you think of a global corporation that fulfils the requirements of the definition given above? See Answer at the end of this chapter.
4.3
Currency volatility
Country
The continuing political acceptance of free-trade by international economies is essential to the success of these strategic investments.
4.4
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Role of factor conditions Human resources skills, (price, motivation, industrial relations) Physical resources (land, minerals, climate, location relative to other nations) Knowledge (scientific and technical know-how, educational institutions) Capital (i.e. amounts available for investment, how it is deployed?) Infrastructure (transport, communications, housing) Role of demand conditions The home market determines how firms perceive, interpret and respond to buyer needs. This information puts pressure on firms to innovate and provides a launch pad for global ambitions.
Basic factors Basic factors include: natural resources, climate, semi-skilled and unskilled labour. Basic factors are inherited, or at best their creation involves little investment.
Advanced factors Advanced factors include modern digital communications, highly educated personnel, research laboratories and so forth. They are necessary to achieve high order competitive advantages such as differentiated products and proprietary production technology.
Comment There are few cultural impediments to communication in the home market. The segmentation of the home market shapes a firm's priorities: companies will generally be successful globally in segments which are similar to the home market. Sophisticated and demanding buyers set standards. Anticipatory buyer needs: if consumer needs are expressed in the home market earlier than in the world market, the firm benefits from experience. The rate of growth: slow growing home markets do not encourage the adoption of state of the art technology. Early saturation of the home market will encourage a firm to export.
Role of related and supporting industries Competitive success in one industry is often linked to success in related industries. Domestic suppliers are preferable to foreign suppliers, as 'proximity of managerial and technical personnel, along with cultural similarity, tends to facilitate free and open information flow' at an early stage.
Comment This facilitates the generation of clusters. These are concentrations of many companies in the same industry in one area, together with industries to support them. For example, London in the UK is a global financial services centre, with a concentration of banks, legal services, accounting services and a depth of specialist expertise. Silicon Valley is a further example.
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Comment National cultural factors create certain tendencies to orientate business people to certain industries. German firms have a strong presence in industries with a high technical content. Industries in different countries have different time horizons, funding needs and so forth. National capital markets set different goals for performance. In some countries, banks are the main source of capital, not equity shareholders. When an industry faces difficult times, it can either innovate within the industry, to sustain competitive position or shift resources from one industry to another (e.g. diversification).
Strategy
Domestic rivalry
With little domestic rivalry, firms are happy to rely on the home market. Tough domestic rivals teach a firm about competitive success. Each rival can try a different strategic approach.
Two other variables, chance events and the role of government, also play their part in determining the competitive environment.
4.4.1
4.4.2
Clusters
Related business and industries are geographically clustered. A cluster is a linking of industries through relationships which are either vertical (buyer-supplier) or horizontal (common customers, technology, skills). Clusters are supposedly a key factor in the competitive advantage of nations.
Within a country, the industry may be clustered in a particular area. The Indian software industry is based in Bangalore. The UK investment banking industry is largely based in London.
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Business strategy
It is easy to see why mining companies should congregate in a cluster around coal seams, or shipping services would congregate around ports, but why should banks and software companies be clustered in the same way, given plentiful IT and broad bandwidth communications? See Answer at the end of this chapter.
4.4.3
This is covered in more detail in Chapter 6. Porter advises management to consider the diamond factors in their home country and to compare them with the diamond factors available to rivals from other countries. He offers the following prescription. If the home diamond factors give a comparative cost advantage over those of foreign rivals then management should adopt strategies based on overall cost leadership. This may explain the strategies of South Korean car manufacturers like Hyundai/Kia, Daewoo and SsangYong (the latter two being respectively offshoots of General Motors and Daimler Chrysler). If the home diamond factors give a differentiation advantage over foreign rivals management should adopt strategies based on differentiation. This may explain why car manufacturers Mercedes, BMW and Audi tend to develop and initially produce their limousines in Germany but build vans and utility cars in Spain, South Africa and Brazil. If the diamond does not confer advantage over rivals then management must focus on sub-sections of the industry which large players may have overlooked or not be able to exploit commercially. This may explain the large number of private banks in Switzerland or the boutique sports car makers in Italy (Ferrari, Lamborghini, Maserati etc). [Difficulty level: Intermediate]
At the Beijing Auto Show (in November 2006) China's car makers felt confident enough to show off not just their newest low-cost runabouts, but also luxury and sports models, 'concept cars' showing future possible designs and even a few hybrid and electric vehicles. Local car makers in the world's third largest and fastest-growing car market would appear to have come of age. Until recently many Chinese car makers built thinly-disguised copies of vehicles made by Volkswagen, GM and Toyota. In the past few years things have changed. In preparation for a push overseas local firms such as Chery, Great Wall and Geely have proved they can develop their own vehicles too. Buying designs from international specialists and installing fancy robotic production lines means more than 100 new models will be introduced in China this year. Their car makers have captured 27% of the market in China and will export 75,000 vehicles to over 100 countries this year. Foreign car makers are worried by the Chinese firms' ultra low prices. The latest Shanghai Maple, for example, with leather seats, anti-lock brakes, air conditioning and a 2 year warranty costs a mere $6,500. Foreign firms grumble that they cannot even buy the steel needed to make the car for that price. How much of this miracle is the result of good business sense rather than special treatment granted to local firms is not entirely clear. A lot of early technology was borrowed. The government also offered support to fledgling firms via direct investments and guaranteed loans. Universities provided technical help, especially in the development of expensive engines. The authorities even considered a law that would mandate a 50% share for local firms by 2010. Future legislation is likely to force foreign firms to do more
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research and development in conjunction with Chinese partners to ensure continued access to cutting-edge engineering skills. In a market where buyers are unashamedly experimental, brands have little value so far, except in the luxury segment. For most buyers cost is more important. With average retail process falling by $1,250 a year producers are racing to cut costs, not improve quality. The number of faults per 100 cars made rose from 246 in 2005 to 338 in 2006. Reliability is likely to deteriorate further. Chinese cars exported today mostly go to Africa, south-east Asia and the Middle East where expectations are lower and price matters more. Requirements (a) Identify, using Porter's Diamond, the sources and nature of any competitive advantage enjoyed by Chinese car manufacturers.
(b) Recommend a strategy for Chinese car makers based on this analysis. See Answer at the end of this chapter.
5.1
Political risk is still relevant with regard to overseas investment, especially in large infrastructure projects overseas. History contains dismal tales of investment projects that went wrong, and were expropriated (nationalised) by the local government. Suspicion of foreign ownership is still rife, especially when prices are raised. Opposition politicians can appeal to nationalism by claiming the government sold out to foreigners. Governments might want to re-negotiate a deal to get a better bargain, at a later date, thereby affecting return on investment.
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Business strategy In addition to expropriation, there are other dangers: Restrictions on profit repatriation (for example, for currency reasons) 'Cronyism' and corruption leading to unfair favouring of some companies over others Arbitrary changes in taxation Pressure group activity
5.2
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Agriculture is a serious issue: campaigners such as Oxfam argue that opening agricultural markets to developing country producers could significantly alleviate global poverty. Sugar might find another use, as fuel alcohol.
Protectionist measures include: Tariffs or customs duties: A tax on imports where the importer is required to pay either a percentage of the value of the imported good (an ad valorem duty), or per unit of the good imported (a specific duty). Non-tariff barriers: Restrictions on the quantity of product allowed to be imported into a country. The restrictions can be imposed by import licences (in which case the government gets additional revenue) or simply by granting the right to import only to certain producers. Minimum local content rules: A specified minimum local content of products should be made in the country or region in which they are sold to qualify as being 'home made' and so avoid other restrictions on imports. This leads manufacturers to set up factories in the country. Minimum prices and anti-dumping action: To stop the sale of a product in an overseas market at a price lower than charged in the domestic market, anti-dumping measures including establishing quotas, minimum prices or extra excise duties are used Embargoes: A total ban or zero quota. Subsidies for domestic producers: Financial help and assistance from government departments that give the domestic producer a cost advantage over foreign producers in export as well as domestic markets. Exchange controls and exchange rate policy: Regulations designed to make it difficult for importers to obtain the currency they need to buy foreign goods. Unofficial non-tariff barriers: Administrative controls such as slow inspection procedures or changing product standards which are hard for foreign suppliers to anticipate and respond to.
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Business strategy Some major regional trade organisations are as follows. Name North American Free Trade Agreement www.nafta-sec-alena.org European Free Trade Association European Union http://europa.eu.int Acronym NAFTA EFTA EU Participating countries US, Canada and Mexico. Norway, Switzerland, Iceland, Liechtenstein. Ireland, Britain, France, Germany, Italy, Spain, Portugal, Finland, Sweden, Denmark, Luxembourg, Belgium, the Netherlands, Austria, Greece. In May 2004, Poland, Hungary, the Czech Republic, Malta, Cyprus, Estonia, Latvia, Lithuania, Slovakia and Slovenia. Brazil, Argentina, Paraguay and Uruguay (Chile is an associate). SADC Angola, Botswana, Lesotho, Malawi, Mozambique, Mauritius, Namibia, South Africa, Swaziland, Tanzania, Swaziland, Zimbabwe. Ivory Cost, Burkina Faso, Niger, Togo, Senegal, Benin and Mali. India, Pakistan, Sri Lanka, Bangladesh, the Maldives, Bhutan and Nepal. Venezuela, Colombia, Ecuador, Peru and Bolivia. ASEAN Indonesia, Malaysia, Philippines, Singapore and Thailand.
West African Economic and Monetary Union www.uemoa.int South Asian Association for Regional Co-operation www.saarc-sec.org Andean Community www.comunidadandina.org Association of Southeast Asian Nations www.aseansec.org
UEMOA SAARC
Regional blocks such as those shown above only extend the benefits of free trade to their members. They may distort, and certainly do not represent, truly global trading patterns. Triad theory describes the international business environment as a limited number of 'superblocks'.
The EU has resisted the scrapping of agricultural subsidies. However, Mercosur is focusing on market access. This renewed negotiations resulting from the failure of the WTO negotiations at Cancun, and waning enthusiasm for a Free Trade Area of the Americas. Argentina, a member of Mercosur, is desperate to expand exports in order to generate growth to overcome its current financial crisis. Mercosur appears to accept that it is pointless trying to change the EU's Common Agricultural Policy.
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The Triad Rather than a globalised world or a federalised world of trading blocks some commentators see economic activity as principally occurring in three main economic blocks: the USA, the EU and Japan. These do the biggest value of their trade with each other. Triad theory rejects the idea that homogenous products can be developed and sold throughout the world. Multinationals have to develop their products for the circumstances of each triad. The Triad theory may be out of date. Japan was, in effect, in recession for 20 years from the mid 1980s whilst emerging markets, particularly those of China and India, but also Brazil, are likely to be some of the world's largest and fastest growing markets. They still have a long way to go before per capita incomes reach the level of the Triad countries. They may form the fourth and fifth trading blocks, or perhaps the triad will be superseded by their faster economic growth.
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Summary
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Self-test
Answer the following questions. 1 PDB Motors Ltd is a major UK car manufacturer with plants in the UK and Europe. It is seeking to exploit both the buoyant North American and Brazilian markets for car sales. Suggest two reasons why it would be a logical strategy for PDB Motors Ltd to build an assembly plant in Mexico. 2 Social and technological factors always need to be assessed when analysing the environment within which a business operates. Give two examples of each of these factors which would be relevant to Busline Ltd, a UK operator of coach tours to Scarborough and Whitby. Suggest how each of your factors may impact future demand. 3 Dunvegan Ltd Dunvegan Ltd is a forestry company operating in the UK, mainly in Scotland. In addition to forests at various stages of maturity, the company also owns many hectares of undeveloped land. So far Dunvegan Ltd's timber has consisted almost exclusively of spruce trees which produce softwood used extensively in building work. Spruce sells for the equivalent of about CU200 per cubic metre. However, genetic engineering has produced a remarkable new tree which has the growth characteristics of spruce, but which produces hard wood with the appearance and qualities of mahogany. This species, the Maho spruce, should grow quite happily in Scotland and produce worthwhile crops after ten years, each Maho spruce tree producing about 2 cubic metres. Currently, mahogany sells for the equivalent of CU900 per cubic metre. The company which developed the Maho spruce has ensured that the trees are sterile and has also successfully applied for world-wide patents on the genetic material. Seedlings are available only from that company at a cost of CU200 each. Dunvegan Ltd is considering whether to invest in Maho spruce. Land already owned by the company would be used and the company's planting and drainage equipment would be assigned temporarily to the project. Because the seedlings are so expensive, relatively light planting would be used at 1,500 seedlings per hectare. Annual maintenance and security would be CU1,000/hectare for each of the ten years of the project. Dunvegan Ltd is considering planting 1,000 hectares with Maho spruce. In the UK Dunvegan Ltd has three main competitors; mahogany is also imported from four countries in the tropics where it is a valuable export. Some of the wood is from managed plantations, but some is from natural forest. Recently the price of mahogany has been rising as supplies become short and plantations have to be renewed. Dunvegan Ltd's accountant has read an article in a recent edition of Lumber About, the monthly trade paper of the timber business, in which the economic effects of the Maho spruce were discussed. If around 3,000-4,000 hectares were planted in the UK, then the price of mahogany would be CU500 per cubic metre at the end of ten years. If around 2,000 hectares only were planted, then the price would be CU800 per cubic metre. Requirement From the viewpoint of an independent consultant, write a memorandum to the directors of Dunvegan Ltd on the proposed Maho spruce plantation. Your memorandum should include an environmental analysis. (20 marks)
Now, go back to the Learning Objectives in the Introduction. If you are satisfied that you have achieved these objectives, please tick them off.
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Answers to Self-test
1 Two reasons from the following: 2 This would allow PDB to take advantage of low labour costs in Mexico. The location would be close to potential major markets, cutting transport costs and reducing lead time. The NAFTA will avoid sales to the USA and Canada being subject to import restrictions. It delivers sales growth prospects to a company facing a saturated European market.
Social factors Two examples form the following: Increasing car ownership (lower demand) Higher proportion of older people in society (higher demand) Cheap overseas packages available (lower demand).
Technological factors Two examples from the following: 3 Development of high speed trains (lower demand) More comfortable coaches being developed (higher demand) Greater internet accessibility, creating more awareness of other travel options (lower demand).
Memorandum To From Date The Directors of Dunvegan Ltd Independent Consultant Today
Subject Proposed Maho spruce plantation The trading environment The Maho spruce project is a ten-year project and it is important to try to predict how the trading environment may change by the time the timber is ready to harvest. However, the time scale obviously makes any predictions unreliable. The environment can first be analysed under the headings Political, Economic, Social, Technological. Political Mahogany currently comes from four countries in the tropics. As it is a valuable export, these countries can be expected to be willing to sell mahogany irrespective of local political changes. In the UK, however, there is growing concern about the deforestation of the tropics and suspicion about the source of many hardwoods. It is possible that the UK or EC will tighten import legislation. Locally grown, renewable mahogany-substitute should be favoured in this ecologically-aware age. Economic Mahogany is principally used for building (window frames, etc) and furniture (veneers). Both of these industries are very sensitive to the health of the economy. It is difficult to predict the economic health of the country ten years hence and so the project will have considerable risk and uncertainty.
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Social If home-owning continues to grow, it is to be expected that demand for high quality materials will also grow. As mentioned under the political paragraph, using tropical hardwoods could become socially unacceptable and it would appear that the Maho spruce should provide a politically correct substitute. However, some people may object to using genetically-engineered material. Technological Although Maho spruce has been patented, there is no reason why other manufacturers could not develop similar products. That would drive down the cost of seedlings (a major cost of the undertaking) and hence the price that would eventually have to be achieved to make the investment pay. Size of investment The proposed investment is large, especially as there are many important factors which could change over the project's life: the project is high risk even if not using innovative technology. Risk could be reduced by planting over several years rather than 1,000 hectares at one time. In that way the economics of the investment could be monitored and decisions taken about each slice of investment. Naturally, this approach would delay the maturity of some of the crop. There is a risk that this would reduce the final income (if mahogany prices were to fall) but prices could also rise (strong reaction against natural mahogany, economic upturn). Delaying planting could also reduce the initial price of seedlings as other bioengineering companies launch new products. Summary Insofar as environmental factors can be judged it would seem that Maho spruce should be a popular product. The main risk arises from technological advances which could produce similar cheaper timber. However, the economics of the project are very dependent on the future price of Maho spruce timber, its substitutes and the reactions of rivals. My advice is as follows: (i) (ii) Attempt to get the suppliers of Maho spruce to regulate sales of the seedlings. Consider spreading out the investment instead of committing so much expenditure in the first year.
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(b) These factors create opportunities and threats. New regulations create a need for professional advisers to provide guidance to clients. Competitors or a thriving labour market with higher pay create threats (incidentally notice how you changed your perspective on the last point because you would like to have the higher pay but you are calling it a threat for your firm). This illustrates how flawed the distinction between 'internal' and 'external' is when we discuss environmental analysis. (c) This will depend on the managers psychological make-up. Some will see it as a tiresome bind that makes them have to keep changing things and also which makes it hard to plan or feel certain. Others will see it as invigorating. A very interesting test of management is the extent to which they see themselves as powerless in the faces of environmental changes or whether they believe they can shape and respond to them. (d) Again, this varies. Some will avoid making decisions which could be affected by environmental uncertainty, and will wait till it settles down (hence incrementalism). Some will simply ignore environmental issues that cannot be proven. Perhaps a more balanced approach is to adopt strategies that would still deliver benefit under a number of environmental developments or perhaps have several courses of action running at the same time, with each one designed to take advantage of different environments. In another context, energy companies invest in several different technologies because they do not know how oil prices and environmental regulations will develop.
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Development of new energy sources such as clean coal, biomass fuel, wave and wind, and reemergence of nuclear power Discovery of new oil or energy reserves
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Business strategy colour pictures, resulting in an uncompetitive stance. The technology required to upgrade the paper to colour printing was very expensive, necessitating an increase in the price of the paper at a time when a price war was emerging. Since then the emergence of on-line services such as news websites and 24 hour-news programming on digital TV have increased the competition to newspapers. As we live in an age where television is the focal point of many people's lives, the accessibility of news/sport and television information has rendered it less important for people to have a newspaper on a daily basis. Newspaper companies have also encountered further costs due to increased technology in the typesetting area which is now centrally controlled and downloaded to regional areas where the printing is done. Once again, to compete on a national basis, this has involved major capital outlay for most companies, which has to be recouped by increased circulation, increased selling prices or increased efficiencies. Given that newspapers are often bought to while away boredom on journeys to and from work etc the development of compact multimedia devices such as MP3 music and video players will reduce the casual purchase of newspapers. (d) Ecological Newspaper production and distribution has many ecological impacts. The raw material is timber and the manufacture of paper involves large amounts of water and bleaches. Print ink was solvent based originally. It is an industry that requires substantial logistics and so leaves a carbon footprint. Regulations affecting pollutants, the recycling of paper, and the carbon emissions from a business would impact sharply on the costs of the newspaper industry. (e) Legal During the recession, in order to boost sales, the tabloids in particular tended to search for more 'popular' stories such as the Royal family and scandals about prominent people. This, however, resulted in an increase in law suits, as a struggle emerged as to whether the private lives of prominent individuals were indeed 'private'. The current ruling is that anything that is in the public interest may be published. However, there remains a grey area as to what is in the 'public interest'. This was then coupled with the manoeuvring by newspapers on the issue of publishing sensitive photographs. Some published in order to obtain a short-term boost to their circulation whereas others decided to publish their 'disgust at those seizing the opportunity' in the hope of a longerterm increase in circulation. The legal issues surrounding the competitive nature of the industry also came to the fore, particularly as to whether the price cuts were an attempt at predatory pricing in order to force a competitor out of business. Conclusion The newspaper industry was in a particularly turbulent phase in the 1990s. This was mainly caused by the recession and the effect this had on disposable incomes. Moreover, with technology everimproving since that time, television and radio have taken increasing shares of the media market away from newspapers.
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3.
4.
(b) The attempt by Chinese car manufacturers to go 'up-market' and develop unique designs and distinctive brands for export is a mistake. It suggests a vanity that could sacrifice the industry's competitive advantage. The appropriate strategy for the industry is to remain a low cost player. It has huge internal markets available to it that value its present offerings. Its low cost position may enable it to focus on export markets such as other developing economies where low cost is also important. However its advantages are location specific and it should access these markets by exporting rather than, say, setting up factories outside China. The poor quality of its products should be addressed. The number of faults is rising and by giving a two-year warranty the firms are bearing the substantial costs of rectifying these. It may be cheaper to stop the faults happening than it is to fix them and it would improve customer perception at home and abroad.
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