External Environment Analysis

Firms shape their activities and strategies according to the environment with which they interact. The environment can provide firms with a variety of opportunities, as well as create some threats. In order to be prepared for these threats and opportunities, the environment must be defined correctly. While businesses can control internal environmental factors,  they  cannot directly control external environmental factors. For eaxample, firms can change their organizational structure when needed, but   they have no control over government policies.

The environmental factors affecting the firm can be assessed according to two main measures:

1. Changeability of markets 
2. Predictability of changes 

While reactive organizations just respond and react to pressures from the environments, proactive organizations seek to manage their environments. For example, a proactive organization takes precautions before new rivals enter the market. However, reactive organizations usually try to develop strategies after problems arise.

Industry environment, also called a task, near or microenvironment, is the environment that includes constituents with direct involvement with the firm.The Industry environment refers to the environment outside the business, but it also interacts directly with the business. In this respect, the industry environment can be considered as a subset of the general environment of the firm. While general environment factors affect every firm in an industry, industrial environment factors are likely to influence organizations themselves. 

The dimensions that make up the industry environment can be classified as three main constituents:
1. Customers
2. Competitors
3. Suppliers

General environment, also known as a societal or far environment, is the environment that includes the factors that do not directly affect the short-term activities of firms but influence long-term decisions. The general environment has an indirect impact on the activities and outcomes of the firms.While firms cannot directly control their general environment, they can predict and prevent possible threats through the measures they can take.

There are four basic activities that businesses should pay attention to in the external environment analysis to predict possible threats and evaluate opportunities:

1.scanning, 2.monitoring, 3.forecasting, and 4.assessing.

Each activity is interlinked and needs to be performed one after another. Firms cannot go a step further without performing previous activities.

Environmental scanning is the process of gathering data by examining the changes in the external environment of the firm. This process of conducting research and gathering external information is sometimes also called industry analysis.

 Through scanning, businesses determine the current appearance of the external environment and identify possible changes in advance. Environmental scanning often reveals ambiguous, incomplete, or disconnected data and informationIn this respect, environmental scanning includes data that are difficult to obtain. Data collection and scanning will not benefit the business unless they are performed regularly. Firms must carry out scanning activities continuously because it changes so frequently. 

Firms must first identify opportunities and threats in their internal and external environment.Once these are identified, the firm can create a strategy that aims to maximize opportunities and minimize threats.

Scanning the external business context should precede the examination of the internal aspects.It is impossible for firms that do not scan their internal environment to keep up with their external environment.

Firms can benefit from quantitative and qualitative forecasting techniques. Each technique has its own advantages and disadvantages.

Qualitative techniques such as Brainstorming, In-depth Interviewing, Delphi Technique, and Expert Opinion are based on the comments of consumers and experts. In Expert Opinion, an expert or a group of industry experts can help the firm forecast possible changes in the future. Another qualitative technique, which is called an industry scenario, is defined as “a scenario that is developed by analyzing the probable impact of future societal forces on key groups in a particular industry”.

Qualitative forecasting techniques are especially useful if a firm does not have sufficient data to reach statistically significant results. However, if a firm has statistical data, then it can benefit from quantitative forecasting.

These techniques which are based on models of mathematics, consist of time series models and associative models. While time series models look at past patterns of data associative models (often called causal models) assume that the variable being forecasted is related to other variables in the environment. In general, quantitative techniques are aimed at linking different variables to establish cause-and-effect relationships that can be used for the benefit of the firm.

The sector, industry, and market concepts are used interchangeably in many textbooks. However, these concepts have different meanings.

To summarize, the “sector” refers to the broader economic groupings covering industries that are similar to each other.

“Industry,” on the other hand, refers to a more specific and narrow grouping. Finally, the “market” is made up of smaller groups of firms and consumer groups that relate more closely to each other.

Let’s consider the automotive industry as an example. In addition to car manufacturers, the automotive sector includes industries such as automotive components, car dealerships, and rental agencies. There are different market segments under the car manufacturers industry such as the commercial vehicle market and passenger vehicles.

A “microenvironment” is the environment where companies sell their products or services, interact with competitors, and provide the materials they need for the production process.

Activities of firms within an industry directly or indirectly affect other businesses. This is due to businesses operating in the same industry that generally target similar consumer groups.If one of the competitors increases its product prices, it will push the other competitors to take action against this, thus affecting competition within the industry. For this reason, this
environment is also called a “competitive environment”.

Porter’s Five Forces model adresses the following interlinked factors:

1.the threat of potential competitors,

2.the threat of substitute products,

3.the power of suppliers,

4.the power of customers, and

5.the competition with existing competitors.

According to Porter’s model, the stronger each of these forces are as shown in the model, the more limited the ability of established companies to raise prices and earn greater profits.The strength of each force in the Porter’s Five
Forces Model may change through time.

Porter’s Five Forces model aims  to describe the attractiveness of an industry. This type of competition analysis refers to a strategic research type.

The main purposes of an industry analysis are:
1. to review the factors that influence the way the industry develops,
2. to investigate the status of competitors,
3. to detect what threats or opportunities they create for the firm,
4. to understand the firm’s position relative to other participants in the industry.

Carrying out this analysis provides information about the competitors and the market in which the firm operates, while at the same time guiding the new strategies to be determined as a result of the analyses.

The factors  that affect the industrial environment of the firms are not limited to the factors in the Porter’s Five Forces Model. In the industry environment analysis, the relationships with the following four constituents should also be taken into account:
1. Strategic Groups
2. Customers
3. Unions
4. Financial Institutions

Strategic groups are firms in the same industry, but which position themselves and their activities differently.

There are other criteria that can be used in the classification of strategic groups,   which are listed as follows:
• Product quality
• Technological superiority
• Distribution channels
• Brand recognition
• Geographic scope
• Research and Development Spending

Businesses should follow the financial decisions and financial institutions
very carefully and develop good relations with them. Businesses with high financial credit scores will be able to overcome financial problems that they may encounter in the future.

Unions are institutions that create a bridge between the worker and the employer and aim to maximize the quality and success of the worker’s life.

In this regard, managing the relations with these institutions that defend the rights of workers is also important for competition management. Businesses should consider situations such as workforce level, productivity, motivation, and union agreements in their strategic decisions.

The general environment of the business is a wider environment that also
affects the overall industrial environment.  In a general environmental analysis, different factors such as economic indicators affecting the whole sector are examined.

In addition to the industry environment, businesses should regularly screen
threats and opportunities in their general environment, since these changes in the general environment can be more destructive for businesses than the changes in the competition environment.

There are some advantages and disadvantages that a general environment analysis offers to firms.

Advantages:

1.Cost effectiveness comes first among these advantages. For example, firms can invest in new machineries that could reduce production costs through analyzing the technological environment.

2.Alertness level is another advantage that the general environment analysis offers to firms. Businesses can improve alertness levels by detecting threats to
external environmental factors in advance. This does not only provide the firm with an effective use of resources, but it also provides them with a competitive advantage. A general environment analysis facilitates product and market adaptation. It is very useful when a new product or service will be introduced to the market. This analysis helps the business adapt to the realities in new markets more quickly.

• increasing managerial awareness of environmental changes,
• increasing understanding of the context in which industries markets function,
• increasing understanding of multinational settings,
• improving resource allocation decisions,
• facilitating risk management,
• focusing attention on the primary influences on strategic change,
• opportunities and threats and devise  appropriate responses.

Disadvantages:

Difficulties of external environment analysis are as follows:
• adapting to the rapid change of external environment factors,
• data collection procedures are time consuming and difficult,
• transforming the obtained data into useful information.

PESTE analysis is  one of the most effective tools used in a general environmental analysis. PESTE aims to identify the opportunities and threats found in the external environment of the business and to identify the elements it interacts with. With the help of PESTE, firms can develop more effective strategies.

A PESTE analysis is usually conducted through a simple brainstorming approach. However, some companies have teams that specialize in a PESTE
analysis. Although there are different versions of it, PESTE generally includes five environmental factors:
P: Political
E: Economic
S: Sociocultural
T: Technological
E: Ecological

The political environment consists of the government, local, state, or federal, and their affiliated political organizations. The political environment analysis focuses on legal regulations, government policies, and political relations with
foreign countries that businesses must comply with. The main factors to consider when analyzing the political environment are:
• Tax policies,
• Labor laws,
• Environmental regulations,
• Commercial restrictions,
• Customs tariffs,
• Political stability.

Political uncertainty, regime change, privatization policies, and expropriation efforts can be mentioned as other issues affecting businesses. Moreover, the political environment may vary depending on whether businesses are a
global or national business. While national firms analyze the political structure of the country they are mostly in, multinational firms should analyze
the political structure and global policies in the countries where they operate.

Economic factors are one of the most important environmental factors that affect a company’s activities. Economic factors are mostly related to issues such as production, distribution, consumption, and reproduction. Economic factors can be listed as

business cycles,

inflation,

national income,

monetary and fiscal policies,

production factor costs,

balance of external payments” 

Business cycles are divided into three periods:depression, recovery, and boom. Businesses should revise their future strategies and activities according to these periods.

There are  also other factors affecting the economic environment of the businesses:
• Production costs,
• The general economic situation in the world,
• Economic growth,
• Money and credit resources,
• Interest rates,
• Exchange,
• Inflation rate,
• Unemployment rates,
• Disposable income,
• Income distribution.

The sociocultural environment has a very important effect in determining the desires and needs of the target audience. In addition, the sociocultural environment is the environment that contains elements such as people’s value judgments, attitudes, behaviors, cultural characteristics, habits, and lifestyles.
Businesses generally cater to consumers at similar economic and sociocultural levels. Firms divide their markets into homogeneous segments to meet consumer demands and needs more effectively.

Demographic and psychographic factors also constitute to the sociocultural structure, and although the fact that sociocultural environment changes slower compared to other environmental factors, firms regularly scan and monitor this environment. Other elements that affect sociocultural factors are:
• Cultural structure
• Educational status
• Birth increase rate and average life
• Work and leisure trends
• Ethnic differences
• Ethics
• Traditions and customs
• Regional differences
• Population growth rate
• Age distribution
• Social mobility
• Consumer trends
• Urbanization
• Customs and traditions
• Attitudes and behaviors

The technological environment is one of the fastest-changing elements in the business environment.  The ability to keep up with this change is one
of the main success factors for today’s businesses.
The ability to keep up with this change is called innovation, which plays a crucial role in enabling businesses to continue their activities successfully.
So much so that this affects the costs of the enterprise to a large extent. 
We can list the factors affecting the technological environmental elements of the business as:
• R&D studies
• IT use
• Using the Internet
• Automation
• Technology incentives
• Technological development speed
• Technology transfers

Decision-making depends on prevailing technological conditions and, increasingly, on the rate of change in the knowledge and technology
base of the external environment  

The ecological environment is defined as a system of many parameters such as nutrients, food, temperature, material resources and social behavior.
The ecological environment also includes subjects such as energy sources, climate change, animal rights, biodiversity, and environmental pollution in the natural environment of the firm.

The unconscious use of the natural environment by businesses leads to the deterioration of the ecological balance. Many businesses today harm
the ecological environment for the mere sake of increasing their profitability.

Green consumers purchase environmentally friendly products and punish businesses that do not fulfill their responsibilities toward the natural environment.Today, protecting the natural environment has become a must, not a choice. Firms must measure and control their impact on the natural
environment. Identifying the damage to the natural environment in any type of the production, both in distribution and marketing activities are important
in terms of cost planning and competitive advantage.