Chapter 2

Macro-environment analysis

Key terms Learning outcomes

forecasting 50 After reading this chapter, you should be able to:
key drivers for change 49 • Analyse the broad macro-environment of organisations in
macro-environment 35 terms of political, economic, social, technological, ecological
nonmarket environment 37 and legal factors (PESTEL).

organisational field 41 • Evaluate different approaches to environmental forecasting.

PESTEL analysis 36 • Construct alternative scenarios in order to address possible

environmental changes.
scenarios 52

Macro-
environment

Industry I Stakeholders
Strategic
position

Resources Culture
 2.1 Introduction

2.1 Introduction
Organisations depend upon their environments for their survival. Here environments are being
understood in their widest sense – to include political, economic, social, technological and
legal factors as well as ecological ones. These environmental factors supply both opportunities
and threats. Political factors helped knock 20 per cent off Facebook’s share price when it was
revealed in 2018 that it had allowed Russian meddling in the American presidential elections
two years earlier. The clustering of millennials as a social group in high-rent cities has prompted
the emergence of new co-living businesses, such as Roomi and Bedly, offering cheap and flex-
ible accommodation. Drone technologies are creating opportunities ranging from audit for
accounting firms such as Deloitte and Ernst & Young to wildlife protection in Africa. It is clearly
important that entrepreneurs and managers analyse their environments as carefully as they
can in order to anticipate and – if possible – take advantage of such environmental changes.
Environments can be considered in terms of a series of ‘layers’, as summarised in
Figure 2.1. This chapter focuses on organisations’ macro-environments, the outermost layer.
The macro-environment consists of broad environmental factors that impact to a greater
or lesser extent many organisations, industries and sectors. For example, the effects of
macro-environmental factors such as the Internet, economic growth rates, climate change
and aging populations go far beyond one industry or sector, impacting a wide-range of
activities from tourism to agriculture. The industry, or sector, makes up the next layer within
this broad macro-environment. This layer consists of organisations producing the same sorts
of products or services, for example the automobile industry or the healthcare sector. The
third layer is that of specific competitors and markets immediately surrounding organisa-
tions. For a car company like Nissan, this layer would include competitors such as Ford and
Volkswagen; for a hospital, competitors would include other hospitals and markets would
be types of patients. Whereas this chapter focuses on the macro-environment, Chapter 3 will
analyse industries and sectors and competitors and markets. Chapters 4 and 5 examine the
individual organisations at the heart of Figure 2.1.

Figure 2.1 Layers of the business environment

cro-environme
The ma nt

Industry (or sector)

Competitors

The
organisation

Markets

35
Chapter 2 Macro-environment analysis

Figure 2.2 Analysing the macro-environment

•
•
PESTEL analysis •
Prediction-emphasis
•
•

Learning-emphasis

Macro-environmental changes can often seem too big, complex or unpredictable for
managers to grasp. The result is that changes can creep up on them until it is too late to
avoid threats or take advantage of opportunities. Thus many traditional retailers, banks and
newspapers were slow to seize the opportunities of the Internet; many oil and steel producers
underestimated the potential impact of China’s slowing economic growth. While managers
are always liable to some biases and inertia (see Chapter 5), this chapter introduces a number
of analytical tools and concepts that can help keep organisations alert to macro-environmental
change. The point is to minimize threats and to seize opportunities. The chapter is organised
in three main sections:

• PESTEL factors examine macro-environmental factors according to six key types: political,
economic, social, technological, ecological and legal. These factors include both market
and nonmarket aspects.
• Forecasting, which aims to predict, with varying degrees of precision or certainty.
Macro-environmental forecasting draws on PESTEL analysis and often makes use of three
conceptual tools: megatrends, inflexion points and weak signals.
• Scenario analysis – a technique that develops plausible alternative views of how the
environment might develop in the future. Scenario analysis differs from forecasting
because it avoids predictions about the future; it is more about learning different possi-
bilities for environmental change.

The structure of this chapter is summarised in Figure 2.2.

2.2 PESTEL analysis

This section introduces a key tool for analysing the broad macro-environment of an organ-
isation: PESTEL analysis. Providing a wide overview, PESTEL is likely to feed into both envi-
ronmental forecasts and scenario analyses.
The PESTEL framework is one of several frameworks (including the similar ‘PEST’ and
‘STEEPLE’ frameworks) which categorise environmental factors into key types.1 PESTEL
analysis highlights six environmental factors in particular: political, economic, social,
technological, ecological and legal. This list underlines that the environment includes not
only the economics of markets, but also nonmarket factors. Organisations need to consider
both market and nonmarket aspects of strategy:2

• The market environment consists mainly of suppliers, customers and competitors. These
are environmental participants with whom interactions are primarily economic. Here

36
 2.2 PESTEL analysis

companies typically compete for resources, revenues and profits. Pricing and innova-
tion are often key strategies here. The market environment is discussed extensively
in Chapter 3, but issues such as economic cycle are also considered in this chapter
(Section 2.2.2).
• the nonmarket environment relates primarily to social, political, legal, and ecological
factors, but can also be impacted by economic factors. The nonmarket environment
typically involves interactions with non-governmental organisations (NGOs), polit-
icians, government departments, regulators, political activists, campaign groups
and the media. In the nonmarket environment, organisations need to build reputation,
connections, influence and legitimacy. Lobbying, public relations, networking and collab-
oration are key nonmarket strategies.

Nonmarket factors are obviously important for government and similar organisations
reliant on grants or subsidies, for example schools, hospitals and charities. However,
nonmarket factors can be very important for business organisations too. For example,
nonmarket factors are particularly important where the government or regulators are
powerful (for instance in the defence and healthcare sectors); where consumer sensitivities
are high (for instance in the food business); or in societies where political, business and
media elites are closely interconnected (typically smaller countries, or countries where the
state is powerful).
The following sections consider each of the PESTEL elements in turn, providing key analyt-
ical concepts and frameworks for each. Meanwhile, Illustration 2.1 on the so-called FANGs
provides examples of various PESTEL factors, showing how in practice they often interrelate.

2.2.1 Politics
The political element of PESTEL highlights the role of the state and other political factors in
the macro-environment. There are two important steps in political analysis: first, identifying
the importance of political factors; second, carrying out political risk analysis.
Figure 2.3 is a matrix that distinguishes two variables helpful to identifying the importance
of political factors:

• The role of the state: in many countries and sectors the state is often important as
a direct economic actor, for instance as a customer, supplier, owner or regulator of
businesses.
• Exposure to civil society organisations: civil society comprises a whole range of organisa-
tions that are liable to raise political issues, including political lobbyists, campaign groups,
social media or traditional media.

To take an example from Figure 2.3, the defence industry faces a highly politicised
environment. Defence companies typically have high direct state involvement: national
armed services are of course key customers, while states are often owners of their national
defence companies. At the same time, defence companies are often highly exposed to
groups from civil society, for instance campaigners against the international arms trade.
By contrast, food companies face less direct state involvement: most food companies are
privately owned and operate in private-sector markets. However, the political environ-
ment is still important for food companies, as they are typically exposed to pressures from
civil society in the form of fair trade campaigners, labour rights organisations and health
lobbying groups. Pressures from civil society organisations can increase state involvement
by demanding additional regulation, for instance buyer health standards for food products.
Canals are often state-owned but nowadays are not highly exposed to political pressures
from civil society organisations. Industries can rapidly change positions: thus revelations

37
Chapter 2 Macro-environment analysis

Illustration 2.1 A PESTEL for the FANGs

In 2018, US technology giants were facing a toughening macro-environment.

Opportunities Threats
High High
Governmental partnerships P Political hostility

New growth regions; diversification E Developed world saturation

S Digital detox

New technologies T Substitutes

E Energy fears

L Online taxation and data constraints

During mid-2018, the so-called FANG+ stock market index usage in Europe, is diversifying into new activities such as
(including Facebook, Amazon, Netflix and Alphabet/ digital dating.
Google) fell by more than 10 per cent. A PESTEL analysis • Social: growing awareness of internet addiction has
helps to explain why. increased consumer willingness to undertake digital
PESTEL analyses can be done using published sources detoxes. In 2018, Google launched a ‘Digital Wellbeing’
(e.g. company annual reports, media articles and consult- app, with user-friendly dashboards giving a detailed view
ants’ reports) or more extensively by direct discussion with on how users spend their time.
managers, customers, suppliers, consultants, academics, • Technological: autonomous planes and balloons are being
government officials and financial analysts. It is important developed by Facebook and Alphabet to deliver internet
not to rely just on an organisation’s managers, who may access to large populations in the developing world. New
have limited views. A PESTEL analysis of the four main FANG technologies may provide substitutes, as Telegram and Sig-
companies based on published sources shows a growing nal provide encrypted alternatives to Facebook Messenger.
preponderance of macro-environmental threats over • Ecological: the FANGs are big energy consumers, with
opportunities (specific industry analysis will be dealt with in cloud computing accounting for 2 per cent of energy con-
Chapter 3). In the figure above, the scale of Opportunities sumption in the USA, and Google using as much power as
and Threats on each of the PESTEL dimensions is indicated San Francisco.
by the relative extent of the bars. Just taking some issues for • Legal: Amazon alone accounts for nearly half of US retail
illustration, the figure shows more and longer bars on the spending, and 80 million Americans are part of its Prime
Threats side than the Opportunities side. Thus: membership programme. Both in the US and Europe,
there is an increasing threat of legal regulation to curb the
• Political: FANG companies face increasing political hostil-
market power of Amazon and other FANG companies.
ity. India has banned Facebook’s Free Basics, a free but re-
stricted internet service. The United Kingdom is planning
specific taxes for online retailers such as Amazon.
• Economic: FANG companies are now facing market sat-
Questions
uration in developed markets. In 2018, Netflix missed 1 Taking one of the FANG companies, what do you think
its subscriber growth targets by one million, and in the is its greatest macro-environmental threat, and what is
USA, the costs required to acquire each new subscriber its greatest macro-environmental opportunity?
have doubled from $60 to $120 (€105; £90.00). Netflix 2 Have the opportunities and threats changed since
is spending big now on producing new content specific- 2018? How would you update this analysis?
ally for international markets. Facebook, facing declining

38
 2.2 PESTEL analysis

Figure 2.3 The political environment

Direct state involvement

High

e.g. Defence industry e.g. Canal industry

Political exposure

High Low

e.g. Food industry e.g. Hotel industry

Low

about Internet monitoring by national security agencies has placed companies such as
Amazon and Facebook much more under scrutiny by governments, civil liberties groups
and consumers (see Illustration 2.1).
Organisations that face politicised environments need to carry out political risk analysis,
the analysis of threats and opportunities arising from potential political change. There are
two key dimensions to political risk analysis:3

• the macro–micro dimension. The macro dimension of political risk refers to the risks
associated with whole countries: for instance Nigeria, Russia or Venezuela. Many
specialist organisations publish relative rankings of countries’ macro political risks.
Western European countries are typically ranked low in terms of macro political risk,
as even changes of government following elections do not bring fundamental change.
On the other hand, some Middle Eastern countries rank high in terms of macro polit-
ical risk, because changes of government there can be sudden and radical.4 However,
there is also an important micro dimension of political risk, relating to the specific risk
of particular organisations or sectors within a country. It is important to distinguish
between macro political risk and specific micro-level risk. China is typically ranked
medium political risk on the macro dimension, but for some Japanese companies oper-
ating there the micro dimension is higher and variable. For many Chinese consumers,
resentment of Japan is strong and Japanese car companies are from time to time
targeted by nationalist boycotts.
• the internal–external dimension. The internal dimension of political risk relates to factors
originating within the countries, for example government change or pressure from local
campaigning groups. These can be relatively easy to monitor, requiring attention to elec-
tion dates and opinion polls for example. However, there are also external political risks,
the knock-on effects of events occurring outside particular countries’ national boundaries.
For example, a fall in oil prices driven by the internal politics of Saudi Arabia is liable to
have negative economic and political impacts on other big oil-producing countries such
as Russia and Venezuela. On the other hand, oil price falls can produce political benefits in
energy importing countries such as India or Japan. External political risk analysis involves
careful analysis of economic, political and other linkages between countries around
the world.

39
Chapter 2 Macro-environment analysis

2.2.2 Economics
The macro-environment is also influenced by macro-economic factors such as currency exchange
rates, interest rates and fluctuating economic growth rates around the world. It is important for
an organisation to understand how its markets are affected by the prosperity of the economy
as a whole. Managers should have a view on how changing exchange rates may affect viability
in export markets and vulnerability to imports. They should have an eye to changing interest
rates over time, especially if they have to borrow to fund strategic investments. They should
understand how economic growth rates rise or fall over time. There are many public sources
of economic forecasts that can help in predicting the movement of key economic indicators,
though these are often prone to error because of unexpected economic shocks.5
A key concept for analysing macro-economic trends is the economic cycle. Despite the poss-
ibility of unexpected shocks, economic growth rates have an underlying tendency to rise and
fall in cycles: several years of good growth are likely to be followed by a couple of years or so
of lower or even negative growth. These cycles link to other important economic variables. For
example, rises in interest rates are likely to decrease economic growth rates as consumers cut
back on credit cards and businesses borrow less for investment. Awareness of cycles reinforces
an important pattern in the macro-environment: good economic times do not last forever, while
bad economic times lead eventually to recovery. The key is to identify cyclical turning points.
Managers making long-term strategic decisions should assess where they stand in the
overall economic cycle. For example, after several years of rapid growth a company might
be tempted to launch major investments in new capacity: in Figure 2.4, this would be year
202x. However, any new facilities might not be needed in the subsequent slowdown, leaving
the company with expensive over-capacity which still needs to be paid for at a time of low
growth. On the other hand, two or three years of slowing growth might make a company
over-cautious about new investment. But after the cyclical turning point of year 202y in Figure 2.4,
the company might face under-capacity and be unable to match recovering demand. Rivals who
had invested in extra capacity (or new products) would be able to seize the advantage, leaving
the over-cautious company struggling to catch up. In assessing the economic environment,
therefore, it is crucial not to assume that current economic growth rates will continue. Before
making any strategic investment, you should ask where you are in the current economic cycle.
Some industries are particularly vulnerable to economic cycles, for example:

• Discretionary spend industries: where purchasers can easily put off their spending for a
year or so, there tend to be strong cyclical effects. Thus demand for furniture, restaurants
and cars tends be highly cyclical because people can easily delay or curtail spending on

Figure 2.4 Economic cycles and strategic investments

Economic
growth rate
(%)

Over-capacity

Under-capacity

202x 202y
Years

40
 2.2 PESTEL analysis

these for a while. After a period of reduced spending, there is liable to be a strong upturn
as pent-up demand is finally released into the market.
• High fixed cost industries: industries such as airlines, hotels and steel suffer from economic
downturns because high fixed costs in plant, equipment or labour tend to encourage
competitive price-cutting to ensure maximum capacity utilisation when demand is low.
For example, an airline might try to fill its seats in the face of falling demand simply by
offering cheap tickets. If its competitors do the same, the resulting price-war will result in
low profits for all the airlines.

2.2.3 Social
The social elements of the macro-environment have at least two impacts upon organisa-
tions. First, they can influence the specific nature of demand and supply, within the overall
economic growth rate. Second, they can shape the innovativeness, power and effectiveness
of organisations.
In the first place, there are a number of key aspects of the social environment that can
shape demand and supply. These can be analysed under the following four headings:

• Demographics. For example, the ageing populations in many Western societies create
opportunities and threats for both private and public sectors. There is increasing demand
for services for the elderly, but diminishing supplies of young labour to look after them.
• Distribution. Changes in wealth distribution influence the relative sizes of markets. Thus
the concentration of wealth in the hands of elites over the last 20 years has constrained
some categories of ‘middle-class’ consumption, while enlarging markets for certain luxury
goods.
• Geography. Industries and markets can be concentrated in particular locations. In the
United Kingdom, economic growth has in recent decades been much faster in the London
area than in the rest of the country. Similarly, industries often form ‘clusters’ in particular
locations: thus there are high concentrations of scientists and engineers in California’s
Silicon Valley (see also Chapter 10).6
• Culture. Changing cultural attitudes can also raise strategic challenges. For example, new
ethical attitudes are challenging profit-maximising investment strategies in the financial
services industry. Changing cultural attitudes can be linked to changing demographics.
Thus the rise of ‘digital natives’ (generations born after the 1980s, and thus from child-
hood immersed in digital technologies) is changing expectations about media, consump-
tion and education.

A second important social aspect of the macro-environment is organisational networks,

with significant implications for innovativeness, power and effectiveness. These networks are
frequently described as ‘organisational fields’.7 An organisational field is a community of
organisations that interact more frequently with one another than with those outside
the field. These organisational fields are partly economic as they include competing organ-
isations within the industry or sector, as well as customers and suppliers in the marketplace
(see Chapter 3). However, the concept of organisational fields also emphasises social inter-
actions with other organisations. Such social interactions may be with other businesses, for
instance via managers who are members of the same industry associations or sporting clubs,
or via non-executive directors who sit on several company boards. There may also be noneco-
nomic interactions with political organisations such as governments and campaign groups,
legal entities such as regulators, and other social groups, such as professions and trade
unions. Sometimes key actors in the field might even be particularly influential individuals,

41
Chapter 2 Macro-environment analysis

for example politicians. The organisational field is therefore much broader than just indus-
tries or markets. Because of the importance of social networks, managers need to analyse the
influence of a wide range of organisational field members, not just competitors, customers
and suppliers.
Networks and organisational fields can be analysed by means of sociograms, maps of
potentially important social (or economic) connections.8 For a new hi-technology enterprise,
important network connections might be links to leading universities, other innovative firms
or respected venture capitalists, for example. Sociograms can help assess the effectiveness of
networks and identify who is likely to be most powerful and innovative within them. Three
concepts help to understand effectiveness, innovativeness and power:

• Network density typically increases network effectiveness. Density refers to the number
of interconnections between members in the network map. Effectiveness is increased by
density because the more interconnections there are, the better the sharing of new ideas
between network members. Everybody is talking to each other, and nobody with poten-
tially useful information is isolated. It is easier to mobilise the whole network in support
of new initiatives. In Figure 2.5, the network on the right (organisation C’s network) is
denser than the network on the left (A’s network).
• Broker positions, which connect otherwise separate groups of organisations, are
often associated with innovativeness. Brokers’ innovation advantage stems from their
ability to link valuable information from one group of organisations with valuable infor-
mation from the other group. Because they provide the connection between the two
groups, they are able to exploit this combination of information before anybody else.
In Figure 2.5, organisation B is a broker, connecting the two networks on the right- and
left-hand sides.
• Central hub positions typically provide power within networks. A central hub connects
many organisations. Hubs have power because network members rely on them for inter-
connection with other members. Hubs are also potentially innovative because they can
collect ideas from the whole network, and they hear about what is going on in one part
of the network before most other parts. In Figure 2.5, both A and C are hubs. However,
organisation A is more central in its immediate network than organisation C (all network
members must pass through A), and to this extent is more powerful relative to its network
members.

Figure 2.5 Sociogram of networks within an organisational field

Organisational field

E D

A B C

C’s immediate network is denser than A’s; B is a broker; A is a more central

hub than C.

42
 2.2 PESTEL analysis

Sociograms can have clear implications for strategic action. For example, organisation A
could gain an advantage over organisation B by establishing direct interaction with organ-
isation C, undermining B’s exclusive broker position. On the other hand, organisation E could
increase its innovativeness and improve its power relative to organisation A by making a
direct connection to organisation D in the right-hand network.
Sociograms can be drawn for key people as well as organisations: individuals are often the
link between organisations anyway. Personal networks are important in many societies, for
example the network of former consultants at the elite McKinsey & Co. consulting firm, or
networks of company directors, or the interpersonal guanxi networks that prevail in China.
Illustration 2.2 describes the network that has emerged from the armed service backgrounds
of many Israeli entrepreneurs. The crucial issue in analysing social networks is how hub posi-
tions, brokering roles and network density are likely to affect a particular organisation’s
power, innovativeness and overall effectiveness.
Some organisational fields can be characterised as ‘small worlds’.9 Small worlds exist
where the large majority of a network’s members is closely connected, either just one step
away (as C is from A in Figure 2.5) or perhaps a couple of steps away (as E is from B). Small
worlds typically give members a good deal of protection and effectiveness, due to their
density. However, outsider organisations (for example foreign firms) will have difficulty
penetrating small world networks on their own, and will typically require the help of insiders.
Small worlds are particularly likely in societies where economic activity is geographically
concentrated or where social elites share common backgrounds (for example, the French
elite is often characterised as living in the same exclusive parts of Paris and as graduating
from a small group of higher education institutions, especially the Grandes Ecoles). Thus an
important aspect of social analysis is the extent of small worlds in the macro-environment.

2.2.4 Technology
Further important elements within the macro-environment are technologies such as the
Internet, nanotechnology or new composite materials, whose impacts can spread far
beyond single industries. As in the case of internet streaming, new technologies can open
up opportunities for some organisations (e.g. Spotify and YouTube), while challenging others
(traditional music and broadcasting companies). Chapter 10 will discuss specific strategies
surrounding innovative new technologies in more detail.
Meanwhile, it is important to carry out the macro-environmental analysis of technology
in order to identify areas of potential innovative activity. There are five primary indicators
of innovative activity:10

• Research and development budgets: innovative firms, sectors or countries can be identi-
fied by the extent of spending on research, typically reported in company annual reports
and government statistics.
• Patenting activity: firms active in patenting new technologies can be identified on national
patent registers, the most important being the United States Patents and Trademarks
Office.
• Citation analysis: the potential impact of patents and scientific papers on technology can
be measured by the extent to which they are widely cited by other organisations, with
data available from Google Scholar for instance.
• New product announcements: organisations typically publicise their new product plans
through press releases and similar media.
• Media coverage: specialist technology and industry media will cover stories of the latest
or impending technologies, as will various social media.

43
Chapter 2 Macro-environment analysis

Illustration 2.2 Intelligence Unit 8200 and the Small World

of Israeli Hi-Tech
Israel, a nation of just 8 million people, exports more than startup, Unit 8200 is a fantastic school. . . . The unit encour-
$6bn worth of cybersecurity products a year, accounting ages independent thought. It’s something that was adopted
for about 10 per cent of the global cybersecurity market. later by many companies, a little like the culture in Google,
At the heart of this success is Unit 8200, the largest unit of in which good ideas can come from anywhere.’
the Israeli Defence Forces and the equivalent of America’s Because recruitment in hi-tech tends to favour a ‘buddy-system’,
National Security Agency. alumni are often sought out for employment by other alumni.
Unit 8200’s alumni have produced more hi-tech start-ups Experience of this intense, elitist organisation in the formative
per capita than the University of Stanford. Some of the years of youth creates strong social bonds. The 8200 alumni asso-
successful companies originating with Unit 8200 include ciation has more than 15,000 members, and hosts networking
Check Point, with 2,900 employees and a pioneer in Virtual events and community outreach programmes, including start-up
Private Networks; NICE Systems, with 2,700 employees and accelerators.
a pioneer in telephone recording technology; and Palo By 2020, Unit 8200 is due to move adjacent to the
Alto Networks, with 3,000 employees and a pioneer in Advanced Technology Park at Be’er Sheva in southern
computer firewall technology. Unit 8200 recruits are drawn Israel’s Negev Desert. In 2013, Israel’s President Benjamin
from young Israelis doing their national military service. Netanyahu had declared that Be’er Sheva would become the
Recruitment into Unit 8200 is highly selective (in the Israeli ‘cybercenter of the Western hemisphere’. Be’er Sheva already
Defence Force, only pilot training is harder to enter) and had the advantage of the local Ben-Gurion University and its
favours skilled computer science students and linguists. Cyber Security Research Centre. The National Cyber Bureau,
Recruits come disproportionately from the richer and more a newly created agency advising the government on cyber
highly educated Tel Aviv area of Israel, and from elite schools policies, moved to Be’er Sheva in 2015. Companies already
such as Leyada, the semi-private Hebrew University High with operations in the Advanced Technology Park included
School in Jerusalem (where the founder of Check Point was many leading foreign firms such as Deutsche Telecom, IBM,
a student). Alumni of Unit 8200 go not only into hi-tech Lockheed Martin, Oracle, PayPal and EMC. Venture capital
business; many pursue successful careers in politics, the firm JVP, with more than $1bn funding available, was also
judiciary, the media and academia. For example, the former running a local ‘cyberincubator’ for start-ups. One of its first
CEO of NICE Systems became director general of the Israeli ventures was sold to PayPal.
Ministry of Finance. Sources: Haaretz, 18 April and 24 April 2015; Financial Times, 10 July
Unit 8200’s young recruits are intensively trained and 2015; TechCrunch, 18 March 2015
work long hours in small groups applying the latest tech-
nology to security matters that might involve life and death.
To maximise security, Unit 8200’s technology systems – from
analytics to data mining, intercept and intelligence manage-
Questions
ment – are designed and built in-house. This experience 1 Identify at least one important hub and one important
prepares Unit 8200 alumni well for futures in hi-tech busi- broker in the Unit 8200 network.
ness. Avi Hasson, Chief Scientist at the Israeli Economy 2 If you were a foreign cybersecurity company, what
Ministry and himself an alumnus of Unit 8200, describes would you do to access Israel’s expertise?
the working environment: ‘When it comes to managing a

44
 2.2 PESTEL analysis

Although there is some variation between firms, sectors and countries in how far their inno-
vative activity is reflected by these kinds of indicators, generally they will help to identify areas
of rapid technological change and locate centres of technological leadership. For example,
the number of patent applications for the new material graphene (a material just one atom
thick, but both strong and highly flexible) increased from less than 100 a year in 2006 to 4,000
a year a decade later. China alone accounts for 58 per cent of the world’s graphene patent
applications and, while 76 applicants that have at least 60 applications each in the sector, 49
of them are Chinese organisations.11 For any organisation seeking a strong position in the
fast-developing graphene industry, links with China will plainly be important.
Many organisations also publish technology roadmaps for their sectors going forward.12
Technology roadmaps project into the future various product or service demands, identify
technology alternatives to meet these demands, select the most promising alternatives and
then offer a timeline for their development. Thus they provide good indicators of future tech-
nological developments. Figure 2.6 provides a simplified technology roadmap for the Internet
of Things, providing connectivity for devices from fridges to heart monitors: in the period to
2033, this roadmap forecasts rapid progress in the number of Central Processing Units (CPUs)
and sensors per device, but less progress in CPU frequency, a measure of processing speed.
This kind of roadmap has implications for product design strategies in industries far beyond
the electronics industry, for instance architecture, domestic appliances and healthcare.

2.2.5 Ecological
Within the PESTEL framework, ecological stands specifically for ‘green’ macro-environmental
issues, such as pollution, waste and climate change. Environmental regulations can impose
additional costs, for example pollution controls, but they can also be a source of opportunity,
for example the new businesses that emerged around mobile phone recycling.

Figure 2.6 Technology roadmap for the Internet of Things

18
CPUs per device
16

14 Max CPU frequency

(MHz x 0.01)
12 Sensors per device

10

0
2019 2021 2024 2027 2030 2033

Source: Drawn from data extracted from the International Roadmap for Devices and Systems, 2018 edition, Institute
for Electronics and Electrical Engineers.

45
Chapter 2 Macro-environment analysis

When considering ecological issues in the macro-environment, there are three sorts of
challenges that organisations may need to meet:13

• Direct pollution obligations are an obvious challenge, and nowadays typically involve not
just cleaning up ‘at the end of the pipe’ (for example, disposing of waste by-products
safely), but also minimising the production of pollutants in the first place. Having clean
processes for supply, production and distribution is generally better than managing the
consequences of polluting after the fact.
• Product stewardship refers to managing ecological issues through both the organisation’s
entire value chain and the whole life cycle of the firm’s products. Stewardship here might
involve responsibility for the ecological impact of external suppliers or final end-users.
It will also involve responsibility for what happens to products at ‘end of life’, in other
words how they are disposed of when consumers have no more use for them. Thus car
manufacturers are increasingly responsible for the recycling and safe disposal of old cars.
• Sustainable development is a criterion of increasing importance and refers not simply
to reducing environmental damage, but to whether the product or service can be
produced indefinitely into the future. This sustainability criterion sets constraints on the
over-exploitation of particular sources of raw materials, for instance in developing countries,
and often raises issues regarding the economic and social well-being of local communities.

In assessing the macro-environment from an ecological point of view, all three criteria of
pollution, stewardship and sustainability need typically to be considered.
The extent to which these ecological criteria are important to organisations relies on three
contextual sources of pressure, the first two arising directly from the macro-environment:

• Ecological. Clearly ecological issues are more likely to be pressing the more impactful
they are: a chemical company may have more to worry about than a school. However,
there are three less obvious characteristics to assess. First, ecological issues become more
salient the more certain they are. For example, as doubts have reduced about the facts of
global warming, so the pressures on organisations to act on it have increased. Pressures
are also likely to be greater the more visible ecological issues are: aircraft pollution is more
salient as an issue than shipping pollution because aircraft are more obvious to ordinary
citizens than pollution done far out to sea. Similarly, the emotivity of the issue is liable to
be a factor: threats to polar bears generally get more attention than threats to hyenas.
Ecological analysis therefore requires assessing certainty, visibility and emotivity.
• Organisational field. Ecological issues do not become salient just because of their inherent
characteristics. The extent of pressure is influenced by how ecological issues interact with
the nature of the organisational field. An organisational field with highly active regulators
or campaign groups will clearly give saliency to ecological issues. However, high levels
of field interconnectedness will also increase the importance of ecological issues: within
densely interconnected networks, it is harder to hide damaging behaviour and peer pres-
sure to conform to ecological standards is greater.
• Internal organisation. The personal values of an organisation’s leadership will clearly influ-
ence the desire to respond to ecological issues. Actual responsiveness will rely on the
effectiveness of managerial systems that promote and monitor behaviours consistent with
ecological obligations.

Although ecological issues can exercise unwelcome pressure, there are potentially strong
organisational motives to respond. As in Figure 2.7, the three kinds of contextual pressure can
satisfy a variety of motives. Fundamentally, there is of course a sense of ecological responsi-
bility: thus the personal values of the organisation’s leaders might stimulate ecological initia-
tives, or routine production systems might reduce pollution. However, another outcome can

46
 2.2 PESTEL analysis

Figure 2.7 Contexts and motives for ecological issues

Contexts Organisational motives

Ecological:
•
•
•

•
•

•
•

Substantially adapted from: Bansal, P. and Roth, K. (2000), ‘Why companies go green: a model of ecological
responsiveness’, Academy of Management Journal, 43(4), 717–36 (Figure 2, p. 729.)

be legitimacy, as reflected in regulatory compliance and a good reputation with consumers.

Finally, responding to ecological issues can even enhance competitiveness. For example, mini-
mising waste in production processes for pollution reasons can reduce costs. Green products
are attractive in the marketplace and often command a price premium.

2.2.6 Legal
The final element in a PESTEL analysis of the macro-environment refers to legal aspects.
These can cover a wide range of topics: for example, labour, environmental and consumer
regulation; taxation and reporting requirements; and rules on ownership, competition
and corporate governance. In recent years, the relaxation of legal constraints through
deregulation has created many new business opportunities, for example for low cost
airlines and ‘free schools’ in various countries. However, regulations can also handicap
organisations: Illustration 2.3 shows how the e-cigarette company Juul ran into important
legal issues as it entered new markets and regulators struggled to keep up with the new
technology.
Legal issues form an important part of the institutional environment of organisations,
by which is meant the formal and informal ‘rules of the game’. 14 This concept of insti-
tutional environment suggests that it can be useful in a PESTEL analysis to consider not
only formal laws and regulations but also more informal norms: the ‘L’ can be stretched
to cover all types of rule, formal and informal. Informal rules are patterns of expected
(ʼnormal’) behaviour that are hard to ignore. Thus, regardless of the law, there are fairly
explicit norms regarding proper respect for the ecological environment. Organisations
ignoring these norms would risk outrage among consumers or employees, whatever the
legal situation.
Formal and informal rules vary sufficiently between countries to define very different
institutional environments, sometimes known as ‘varieties of capitalism’.15 These vari-
eties of capitalism have implications for the ways in which business and management
are done in those environments and the prospects for success, both for insiders and for
outsiders. Although every country differs in detail, three broad varieties of capitalism

47
Chapter 2 Macro-environment analysis

Illustration 2.3 Juul duels with the rules

The fashionable e-cigarette company addresses regulatory environments
internationally.

Adam Bowen and James Monsees launched their distinctive media code underlining that its products were not appro-
Juul e-cigarette in 2015. The product’s sleek style led to the priate for young people, switched to using only models
Juul becoming known as the ‘iPhone of e-cigarettes’. Juul aged over 35, restricted the availability of sweet flavours,
became the most popular e-cigarette in the United States and made increasing use of traditional television rather than
by the end of 2017, and by the end of 2018 commanded a social media channels. At the same time, it began exploring
market share of over 70 per cent. In November 2018, the markets overseas.
Altria Group (a traditional tobacco company) bought one Juul’s first overseas market was Israel, which it entered
third of the company for $12.8bn, making the two founders early in 2018. At the time, Israel had no regulations on
billionaires. e-cigarettes. However, the Israeli government responded
Bowen and Monsees dreamt up their colourful e-cigarettes within two months, banning Juul on the grounds that its
while pursuing their master’s degrees at Stanford Univer- 5 per cent nicotine concentration was two and a half times
sity. They were smokers themselves, wanting to free them- the level required by the European Union, a norm that Israel
selves of a dirty and dangerous habit. The Juul design uses freely adopted. Juul next launched in the United Kingdom,
a patented form of nicotine salts, at 5 per cent strength, still in the European Union, using a formulation with less
to deliver the quick nicotine peak associated with trad- than 2 per cent nicotine. In late 2018, Juul launched in
itional cigarettes. The website for their company declares Canada, where a relaxed legal regime allowed it to offer
its mission as to ‘improve the lives of the world’s one billion both 3 and 5 per cent formulations plus a range of flavours
adult smokers by eliminating cigarettes’. Juul claims that it larger than the recently restricted ones in the US.
has converted one million adult smokers to Juul products, At the same time, Juul was revealed to be considering
allegedly a safer product. expansion into Asia. Indonesia was one potential target
Traditional tobacco companies typically rely on television market, given its fast-growing population of nearly 270
advertising, but Juul initially focused on powerful social million. Indonesia is also one of a handful of countries
marketing campaigns featuring attractive young models which has not signed the World Health Organization’s
and singers on Instagram, Twitter and YouTube. Campaigns global treaty on tobacco control: two thirds of Indonesian
went viral, with celebrities such as Bella Hadid posting men smoke tobacco daily. Other markets Juul was reportedly
about Juul. The result was a surge of use among teenagers, considering were Malaysia, Singapore, India, South Korea
attracted also by Juul’s sweet flavours and by the fact that its and the Philippines.
small size and low odours help concealment. In 2018, it was Main sources: Fast Company, December/January 2018/19; Reuters
estimated that 3.6 million American schoolchildren were Business News, 18 November 2018; Forbes, 16 November 2018; www
using e-cigarettes, presumptively mostly Juuls. .juul.com.
However, Juul faced increasing criticism from the media,
health professionals and regulators over its marketing. Nico-
tine addiction can cause substantial damage to the devel-
oping brain, including lasting impairment to memory and
Questions
attention span, and increased psychiatric conditions such as 1 Assess the relative importance of formal laws and
depression and anxiety. Four lawsuits were filed in 2018 in informal norms for the development of Juul’s strategy
the United Sates against Juul by parents, underage users and in the United States.
others, attacking its marketing strategy and safety claims. 2 How do you think the different institutional environ-
Monsees declared: ‘Any underage consumers using this ments internationally have influenced Juul’s overseas
product are absolutely a negative for our business. We strategy so far and what kinds of countries do you think
don’t want them. We will never market to them. We never it should prioritise?
have.’ The company launched a new marketing and social

48
 2.2 PESTEL analysis

have been identified, whose formal and informal rules lead to different ways of
doing business:

• Liberal market economies are institutional environments where both formal and informal
rules favour competition between companies, aggressive acquisitions of one company
by another and free bargaining between management and labour. Companies in these
liberal market economies tend to raise funds from the financial markets and company
ownership is either entrepreneurial or, for older companies, widely dispersed among
many shareholders. These economies tend to support radical innovation and are recep-
tive to foreign firms. Although neither is perfectly representative, the United States and
the United Kingdom correspond broadly to this type of institutional environment.
• Coordinated market economies encourage more coordination between companies, often
supported by industry associations or similar frameworks. There are legal and normative
constraints on hostile acquisitions on the one hand, and various supports for consensual
and collective arrangements between management and labour on the other. Companies
in these coordinated market economies tend to rely on banks for funding, while family
ownership is often common. These economies support steady innovation over the
long-run and, because of coordination networks, are typically less easy for foreign firms to
penetrate. Again, neither is perfectly representative, but Germany and Japan correspond
broadly to this type of institutional environment.
• Developmental market economies tend to have strong roles for the state, which will either
own or heavily influence companies that are important for national economic devel-
opment. Formally or informally, the state will often encourage private-sector firms to
coordinate between themselves and with national economic policy-makers. Labour rela-
tions may be highly regulated. Banks, often state-owned, will be a key source of funding.
Long-term, infrastructural and capital-intensive projects may be favoured, but foreign
firms will often be at a disadvantage. Although each is very different in its own way, Brazil,
China and India all have aspects of this developmental market economy environment.

A macro-environmental analysis of any particular country should therefore include an assess-

ment of the local variety of capitalism and the extent to which it favours particular kinds of
firm and strategy.

2.2.7 Key drivers for change

The previous sections have introduced a variety of concepts and frameworks for analysing
each of the PESTEL factors, particularly at a macro-level. As can be imagined, analysing these
factors, together with their interrelationships, can produce long and complex lists of issues.
Rather than getting overwhelmed by a multitude of details, it is necessary to step back to
identify the key drivers for change in a particular context.16 Key drivers for change are the
environmental factors likely to have a high impact on industries and sectors, and the
success or failure of strategies within them.
Key drivers thus translate macro-environmental factors to the level of the specific industry
or sector. Thus social and legislative changes discouraging car use might have different and
greater effects on supermarkets than, for example, retail banks. Identifying key drivers for
change in an industry or sector helps managers to focus on the PESTEL factors that are most
important and which must be addressed most urgently. Without a clear sense of the key
drivers for change, managers will not be able to take the strategic decisions that allow for
effective responses: to return to the example above, the supermarket chain might address
reduced car use by cutting the number of out-of-town stores and investing in smaller urban
and suburban sites. It is important that an organisation’s strategists consider each of the
key drivers for change, looking to minimise threats and, where possible, seize opportunities.

49
Chapter 2 Macro-environment analysis

2.3 Forecasting
In a sense, all strategic decisions involve forecasts about future conditions and outcomes. Thus
a manager may decide to invest in new capacity because of a forecast of growing demand
(condition), with the expectation that the investment will help capture increased sales
(outcome). PESTEL factors will feed into these forecasts, for example in tracking economic
cycles or mapping future technologies. However, accurate forecasting is notoriously diffi-
cult. After all, in strategy, organisations are frequently trying to surprise their competitors.
Consequently, forecasting takes three fundamental approaches to the future based on
varying degrees of certainty: single-point, range and multiple-futures forecasting. This
section explains these three approaches and also introduces some key concepts that help
explore the direction of future change.

2.3.1 Forecast approaches

The three approaches to forecasting are explored in the following and illustrated in
Figure 2.8:17

• Single-point forecasting is where organisations have such confidence about the future
that they will provide just one forecast number (as in Figure 2.8 i). For instance, an
organisation might predict that the population in a market will grow by 5 per cent in the
next two years. This kind of single-point forecasting implies a great degree of certainty.
Demographic trends (for instance the increase in the elderly within a particular popula-
tion) lend themselves to these kinds of forecasting, at least in the short term. They are
also often attractive to organisations because they are easy to translate into budgets:
a single sales forecast figure is useful for motivating managers and for holding them
accountable.
• Range forecasting is where organisations have less certainty, suggesting a range of
possible outcomes. These different outcomes may be expressed with different degrees
of probability, with a central projection identified as the most probable (the darkest
shaded area in Figure 2.8 ii), and then a range of more remote outcomes given decreasing
degrees of likelihood (the more lightly shaded areas). These forecasts are often called
‘fan charts’, because the range of outcomes ‘fans out’ more widely over time, reflecting
growing uncertainty over the longer term. These ‘fan charts’ are often used in economic
forecasting, for example economic growth rates or inflation.

Figure 2.8 Forecasting under conditions of uncertainty

Outcomes Outcomes Outcomes

Unlikely
A
Possible
Probable
B
Possible
C
Unlikely

Time Time Time

(i) Single-point forecast (ii) Range forecast (iii) Alternative futures

Low Uncertainty High

50
 2.3 Forecasting

• Alternative futures forecasting typically involves even less certainty, focusing on a set of
possible yet distinct futures. Instead of a continuously graduated range of likelihoods,
alternative futures are discontinuous: they happen or they do not, with radically different
outcomes (see Figure 2.8 iii). These alternatives might result from fundamental policy deci-
sions. For example, for a country facing possible exit from a currency union (for instance
the Euro), outcome A might reflect the consequences for growth or unemployment of
staying in the union; outcome B might reflect the consequences of exiting the union;
and outcome C would be a further alternative outcome, consequent on a decision that
followed the initial decision pointing towards outcome B (for instance, to adopt trade
barriers as well as to exit the currency union). For a business, outcome A might represent
expected sales if a competitor business did not invest in a new machine or similar capacity;
outcome B is a consequence of the competitor making that investment; and outcome
C is a consequence of the competitor both making that investment and then slashing
prices to make full use of the new capacity. It is possible to put probabilities to each of
these outcomes too: for example, outcome A might have a 40 per cent probability, while
outcomes B and C would be 30 per cent each. These kinds of alternative futures are often
fed into scenario analyses (see Section 2.4), though not as simple forecasts.

2.3.2 Directions of change

It is helpful in forecasting to keep an eye on the fundamental directions of likely change.
Managers need to check their forecasts are consistent with major trends and to be alert to
possible turning points. Three concepts help focus both on major trends and on possible
turning points that might invalidate existing forecasts:

• Megatrends are large-scale political, economic, social, technological, ecological or legal

movements that are typically slow to form, but which influence many areas of activity,
possibly over decades.18 A megatrend typically sets the direction for other factors. Thus
the social megatrend towards ageing populations in the West influences other trends in
social care, retail spending and housing. The megatrend towards global warming affects
agriculture, tourism and, with more extreme climatic events, insurance. It is important to
identify major megatrends because they influence so many other things. Forecasts should
be checked for consistency with such trends.
• Inflexion points are moments when trends shift in direction, for instance turning sharply
upwards or downwards.19 For example, after decades of stagnation and worse, in the
early twenty-first century sub-Saharan Africa may have reached an inflexion point in
its economic growth, with the promise of substantial gains in the coming decade or so.
Internet retailing may also have put urban shopping on a path to significant decline in
advanced economies. Inflexion points are likely to invalidate forecasts that extrapolate
existing trends. Clearly it is valuable to grasp the inflexion point at the moment when
trends just start to turn, in order either to take advantage of new opportunities early or
to act against escalating decline as soon as possible.
• Weak signals are advanced signs of future trends and are particularly helpful in identi-
fying inflexion points.20 Typically these weak signals are unstructured and fragmented
bits of information, often perceived by observers as ‘weird’. A weak signal for the world-
wide financial crisis that began in 2008 was the rise in mortgage failures in California the
previous year. An early weak signal foreshadowing the current success of Asian business
schools was the first entry of the Hong Kong University of Science and Technology into the

51
Chapter 2 Macro-environment analysis

Financial Times’ ranking of the top 50 international business schools in the early 2000s. It is
important to be alert to weak signals, but it is also easy to be overwhelmed by ʼnoise’, the
constant stream of isolated and random bits of information without strategic importance.
Some signs of truly significant weak signals (as opposed to mere noise) include: the repe-
tition of the signal and the emergence of some kind of pattern; vehement disagreement
among experts about the signal’s significance; and an unexpected failure in something
that had previously worked very reliably.

2.4 Scenario analysis

Scenarios offer plausible alternative views of how the macro-environment might develop
in the future, typically in the long term. Thus scenarios are not strategies in themselves,
but alternative possible environments which strategies have to deal with. Scenario analysis is
typically used in conditions of high uncertainty, for example where the environment could go
in several highly distinct directions.21 However, scenario analyses can be differentiated from
alternative futures forecasting (Section 2.3.1), as scenario planners usually avoid presenting
alternatives in terms of finely calculated probabilities. Scenarios tend to extend too far into
the future to allow probability calculations and besides, assigning probabilities directs atten-
tion to the most likely scenario rather than to the whole range. The point of scenarios is
more to learn than to predict. Scenarios are used to explore the way in which environmental
factors inter-relate and to help keep managers’ minds open to alternatives possibilities in
the future. A scenario with a very low likelihood may be valuable in deepening managers’
understanding even if it never occurs.
Illustration 2.4 shows an example of scenario planning for the world of work to 2030,
published by the international advisory firm PwC. The scenarios start from five megatrends
covering a range of factors from technology to natural resources. PwC then identifies two
drivers which are clearly differentiated on the dimensions of the scenario cube in terms of
having (i) high potential impact; (ii) high uncertainty; (iii) high independence from each other
(see Figure 2.9 and below). The first of these two drivers is political, i.e. collectivism versus indi-
vidualism, referring to the roles of government. The second of these key drivers addresses the
nature of business, i.e. integration versus fragmentation, pointing to the relative importance

Figure 2.9 The scenario cube: selection matrix for scenario key drivers

Low
Independence
High

High

Uncertainty

Low

Impact
Low High
Select key drivers in the high-impact, high-uncertainty, high-independence box

52
 2.4 Scenario analysis

Illustration 2.4 Colouring the World

In 2018, PwC’s People and Organisation’s consulting practice published a major report
on four scenarios for the world of work in 2030.

Fragmentation

Yellow World Red World

– humans come first – innovation rules

Collectivism Individualism

Green World Blue World

– companies care – corporate is king

Integration

Adapted from: PWC US (2018), ‘The competing forces shaping 2030’, https://www.pwc.com/us/en/services/hr-management/workforce-of-the-
future.html

Wanting to provide its clients with long-term advice about the These two axes yielded four scenario stories, as summarised
future evolution of work, PwC cooperated with researchers at in the figure above:
the James Martin Institute for Science and Civilisation at the Saïd Briefly, the four scenarios for 2030 were as follows:
Business School, University of Oxford, to produce four scenarios
1. Yellow World, in which social enterprises and community
each named after a distinct colour. The researchers drew on
businesses flourish. Crowdfunded capital flows towards eth-
a specially commissioned survey of 10,000 people in China,
ical brands. Meaningful work is important. Artisans and craft
India, Germany, the UK and the US and built on the concept of
production thrive. Human values have priority.
megatrends.
2. Red World, in which consumers are dominant, and organisations
The five megatrends underpinning all the scenarios were:
and individuals race to serve them. Regulation cannot keep up with
1. Rapid advances in technological innovation, particularly au- innovation. Competition tends towards ‘winner takes all’ results.
tomation, robotics and artificial intelligence. However, specialists and niche businesses do well.
2. Demographic shifts, especially aging populations and work- 3. Green World, in which social responsibility and trust are cru-
forces. cial for large corporations and demographic and climate
3. Rapid urbanisation, from about 5bn people to 8bn by 2030. changes are key drivers for business.
4. Shifts in global economic power, with today’s rapidly devel- 4. Blue World, in which big business dominates, and individual
oping nations such as China gaining particularly, while within wants have priority over social responsibilities.
nations new technologies will threaten employment for the
Source: ‘Workforce of the future: The competing forces shaping 2030’,
traditional middle classes. PwC, 2018: www.pwc.com/us/en/hr-management/pwc-workforce-
5. Resource scarcity, as demand for energy and water will in- of-the-future-the-competing-forces-shaping-2030.pdf
crease respectively by 50 per cent and 40 per cent by 2030.
On this basis, the PwC-Oxford team developed two main axes
upon which to differentiate their scenarios: collectivism versus
Questions
individualism and fragmentation versus integration. Collectivism 1 What other megatrends might have been considered
implies a strong role for governments in society, individualism beyond the five considered here?
more self-reliance. Integration implies an advantage for big busi- 2 What are the different implications of these scenarios
nesses able to integrate and coordinate many activities; fragmen- for an international consulting firm such as PwC? Which
tation implies an important role for small firms and organisations. scenario would it like best; which would it like least?

53
Chapter 2 Macro-environment analysis

Figure 2.10 The scenario process

Define Identify Develop Identify Monitor

scope key drivers distinct impacts progress
(industry, (PESTEL, scenario (check and (early
region, forecasts, ‘stories’ adapt warning
years) cube) (name strategies) indicators)
scenarios)

of big and small firms. Both of these drivers may produce very different futures, which can be
combined to create four internally consistent scenarios for the next decade or so. The various
scenarios draw in distinct ways on the megatrends: for example, Green World assumes a
different response to resource scarcity than Blue World; Red World is less optimistic than
Green World about the capacity of government regulators to keep up with technological
change. PwC does not predict that one scenario will prevail over the others, nor do they
allocate relative probabilities. Prediction would close managers’ minds to alternatives, while
probabilities would imply a spurious kind of accuracy over this period of time.
While there are many ways to carry out scenario analyses, the process often follows five
basic steps (summarised in Figure 2.10):22

• Defining scenario scope is an important first step in the process. Scope refers to the subject
of the scenario analysis and the time span. For example, scenario analyses can be carried
out for a whole industry globally, or for particular geographical regions and markets.
While businesses typically produce scenarios for industries or markets, governments often
conduct scenario analyses for countries, regions or sectors (such as the future of healthcare
or higher education). Scenario time spans can be either a decade or so (as in Illustration
2.4) or perhaps just five years ahead. The appropriate time span is determined partly by
the expected life of investments. In the energy business, where oil fields might have a life
span of several decades, scenarios often cover 20 years or more.
• Identifying the key drivers for change comes next. Here PESTEL analysis can be used to
uncover issues likely to have a major impact upon the future of the industry, region or
market. In the information technology, key drivers range from regulation to innovation.
The scenario cube (Figure 2.9) helps identify the most significant key drivers. As well as
the size of impact, the scenario cube underlines two additional criteria for key drivers:
uncertainty, in order to make different scenarios worthwhile (there’s no point in devel-
oping alternative scenarios when only one outcome is likely); and mutual independence,
so that the drivers are capable of producing significantly divergent or opposing outcomes
(there’s no point in considering factors individually if they lead to the same outcome
anyway). In the oil industry, for example, political stability in the oil-producing regions
is one major uncertainty; another is the development of new exploration technologies,
enabling the quick and efficient identification of new oil fields. These could be selected
as key drivers for scenario analysis because both are uncertain and regional stability is not
closely correlated with technological advance.
• Developing scenario ‘stories’. As in films, scenarios are basically stories. Having selected
opposing key drivers for change, it is necessary to knit together plausible stories that incor-
porate both key drivers and other factors into a coherent whole. These stories are often
encapsulated with striking titles: for example, oil company Shell launched two opposing
scenarios entitled simply ‘Oceans’ and ‘Mountains’, the first describing a more free-market
world with solar power important, the second a more government-led world, with gas
power important.23 Striking titles help to communicate scenarios and embed them in
strategic discussions (see also Illustration 2.4).

54
 Thinking differently the crowdsourced forecast

• Identifying impacts of alternative scenarios on organisations is the next key stage of

scenario building. For example, in Illustration 2.4, a Blue World would pose major
challenges for small and ethical businesses. It is important for an organisation to carry
out robustness checks in the face of each plausible scenario and to adapt strategies that
appear vulnerable and develop contingency plans in case they happen.
• Monitor progress. Once the various scenarios are drawn up, organisations should
monitor progress over time, to alert themselves to whether and how developments
actually fit scenario expectations. Here it is important to identify indicators that might
give early warning about the final direction of environmental change, and at the same
time set up systems to monitor these. Effective monitoring of well-chosen indicators
should facilitate prompt and appropriate responses. In Illustration 2.4, the diminishing
likelihood of a Red World would be growing regulation of technology firms such as Uber
and airbnb.

Because debating and learning are so valuable in the scenario-building process, and they
deal with such high uncertainty, some scenario experts advise managers to avoid producing
just three scenarios. Three scenarios tend to fall into a range of ‘optimistic’, ‘middling’ and
‘pessimistic’. Managers naturally focus on the middling scenario and neglect the other two,
reducing the amount of organisational learning and contingency planning. It is therefore
typically better to have two or four scenarios, avoiding an easy mid-point. It does not matter
if the scenarios do not come to pass: the value lies in the process of exploration and contin-
gency planning that the scenarios set off.

Thinking differently The crowdsourced forecast

Do we need experts to forecast anymore?

We usually think of forecasts (Section 2.3) as the product prepared to bet on their success, then probably the new
of small groups of experts. But there is a different way. products will indeed turn out well. The bets of many
Forecasts can be ‘crowdsourced’, using the collective employees may be more reliable than the self-interested
judgement of many different kinds of people, not just forecasts of the product’s own developers.
experts. There are two principal ways of using the Internet media such as Twitter and Google can also
wisdom of crowds in forecasting: prediction markets and provide forecasts, drawing on the inputs of many thou-
internet media analysis. sands of users. For example, Google Trends analyses the
Prediction markets are markets designed specifically frequency with which people search about flu symptoms
to combine the scattered information of many partici- to predict the onset of flu epidemics. Others analyse the
pants into values (for instance, market prices or betting mix of positive and negative sentiments expressed by
odds) that can be used to make predictions about specific ordinary people in Twitter feeds to forecast the direc-
future events.24 An example is the Iowa Electronic Market tion of financial markets, up or down.25 Data about what
(IEM) for betting on the outcome of American Presiden- people are interested in, or how they feel, provides valu-
tial elections. Market participants buy a contract that able clues to what will happen next.
pays a dollar if, for instance, a Democrat wins the elec-
tion. The more money participants are prepared to pay
for that contract, the more likely it appears that a Demo- Question
crat will indeed win that election. Google uses similar Why might experts make bad forecasters in the case of
prediction markets to forecast the success of possible i. Presidential elections; ii. new product developments?
new products: if many people within the company are

55
Chapter 2 Macro-environment analysis

Summary
• Environmental influences can be thought of as layers around an organisation, with the
outer layer making up the macro-environment, the middle layer making up the industry
or sector and the inner layer strategic groups and market segments.
• The macro-environment can be analysed in terms of the PESTEL factors – political, economic,
social, technological, ecological and legal.
• Macro-environmental trends can be forecast according to different levels of uncertainty,
from single-point, through ranges to multiple-futures.
• A PESTEL analysis helps identify key drivers of change, which managers need to address in
their strategic choices. Alternative scenarios about the future can be constructed according
to how the key drivers develop.

Work assignments
✱ Denotes more advanced work assignments.
* Refers to a case study in the Text and Cases edition.

2.1 For an organisation of your choice, carry out a PESTEL analysis and identify key
opportunities and threats. Use Illustration 2.1 as a model. For simplicity, choose an
organisation that is focused on a limited number of industries.
2.2 For your own country, or any other country with which you are familiar, look up the
political risk as assessed by Aon, the Economist Intelligence Unit or similar (see refer-
ences in endnote 4). How far do you agree with this assessment?
2.3 For the last year or two, review the forecasts for national or global economic growth
made by key forecasting organisations such as the OECD or the World Bank (see
references in endnote 5). How accurate were they? What accounts for any difference
between forecast and outcomes?
2.4✱ For the same organisation as in assignment 2.1, and using Illustration 2.4 or Siemens
A as a model, construct four scenarios for the evolution of its macro-environment
(or main industry or sector). What implications are there for the organisation’s strategy?

Integrative assignment
2.5 Carry out a full analysis of an industry or sector of your choice (using for example
PESTEL and scenarios). Draw also on the five forces and strategic groups analyses of
Chapter 3. Consider explicitly how the industry or sector is affected by globalisation
(see Chapter 9, particularly Figure 9.2 on drivers) and innovation (see Chapter 10,
particularly Figure 10.2 on product and process innovation).

Recommended key readings

• An overview of techniques for thinking ahead is in P. Times: New methods for applying scenarios, Taylor &
Tetlock and D. Gardner, Superforecasting: the Art and Francis, 2010.
Science of Prediction, Crown, 2015. For approaches • A collection of academic articles on PEST, scenarios
to how environments change, see K. van der Heijden, and similar is the special issue of International Studies
Scenarios: The Art of Strategic Conversation, 2nd of Management and Organization, vol. 36, no. 3
edition, Wiley, 2005 and R. Ramírez, J.W. Selsky and K. (2006), edited by Peter McKiernan.
Van der Heijden (eds), Business Planning for Turbulent

56
 References

References
1. PESTEL is an extension of PEST (Politics, Economics, Great Strategies’, Strategy Science, vol. 2, no. 4 (2017),
Social and Technology) analysis, taking more account pp. 226–33.
of ecological (‘green’) and legal issues. PEST is some- 9. M.A. Sytch, A. Tatarynowicz and R. Gulati, ‘Toward
times called STEP analysis. PESTEL is sometimes called a theory of extended contact: the incentives and
PESTLE and is also sometimes extended to STEEPLE in opportunities for bridging across network communi-
order to include ethical issues. For an application of ties’, Organization Science, vol. 23, no. 6 (2012), pp.
PEST analysis to the world of business schools, see H. 1658–81.
Thomas, ‘An analysis of the environment and compet- 10. J. Hagedoorn and M. Cloodt, ‘Measuring innovative
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2. J. Doh, T. Lawton and T. Rajwani, ‘Advancing 11. Z. Zhao, ‘China No 1 in world patent applications for
nonmarket strategy research: institutional perspec- graphene tech’, China Daily, 2 February 2018.
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Perspectives, August (2012), pp. 22–38; S. Dorobantu, improving technology roadmap credibility: a
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Management Journal, vol. 38, no. 1 (2017), pp. 114–40. 13. S.L. Hart and G. Dowell, ‘A natural-resource-based view
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micro political risk and the multinational firm’, Busi- ment, vol. 37, no. 5 (2010), pp. 1464–79.
ness Horizons, vol. 52, no. 2 (2009), pp. 127–37; J. 14. J. Cantwell, J.H. Dunning and S.M. Lundan, ‘An evolu-
Jakobsen, ‘Old problems remain, new ones crop up: tionary approach to understanding international busi-
political risk in the 21st century’, Business Horizons, ness activity: the co-evolution of MNEs and the institu-
vol. 53, no. 5 (2010), pp. 481–90; Sottilotta, C. ‘Polit- tional environment’, Journal of International Business
ical risk assessment and the Arab Spring: What can we Studies, vol. 41, no. 4 (2010), pp. 567–86. See also M.
learn?’ Thunderbird International Business Review, vol. Peng, H. Nguyen, J. Wang, M. Hasenhüttl and J. Shay,
57, no. 5 (2015), pp. 379–90. ‘Bringing institutions into strategy teaching’, Academy
4. Organisations such as the insurance company Aon, of Management Learning & Education, Vol. 17, No. 3
and economic media such as the Economic Intell- (2018), pp. 259–78.
igence Unit and Euromoney, publish regular rankings 15. M.A. Witt and G. Redding, ‘Asian business systems:
of country political risk. institutional comparison, clusters and implications
5. Macroeconomic forecasts can be found at: www for varieties of capitalism and business systems
.oecd.org/eco/outlook/; www.imf.org/external/; theory’, Socio-Economic Review, vol. 11, no. 2 (2013),
www.worldbank.org/ pp. 265–300, and M.R. Schneider and M. Paunescu,
6. M.E. Porter, ‘Clusters and the new economics of compe- ‘Changing varieties of capitalism and revealed
tition’, Harvard Business Review, vol. 76, no. 6 (1997), comparative advantages from 1990 to 2005: a test of
p. 7790. the Hall and Soskice claims’, Socio-Economic Review,
7. A useful review of research on this topic is: R. Suddaby, vol. 10, no. 4 (2012), pp. 731–53.
K.D. Elsbach, R. Greenwood, J.W. Meyer and T.B. Zilber, 16. R. Vecchiato, and C. Roveda ‘Strategic foresight in
‘Organizations and their institutional environments – corporate organizations: handling the effect and
Bringing meaning, values, and culture back in: Intro- response uncertainty of technology and social drivers
duction to the special research forum’, Academy of of change’, Technological Forecasting and Social
Management Journal, vol. 53, no. 6 (2010), pp. 1234–40. Change, vol. 77, no. 9 (2010), pp. 1527–39.
For a more general review see G. Johnson and R. 17. U. Haran and D.A. Moore, ‘A better way to forecast’,
Greenwood, ‘Institutional theory and strategy’, in Stra- California Management Review, vol. 57, no. (2014),
tegic Management: a Multiple-Perspective Approach, pp. 5–15; H. Courtney, J. Kirkland and P. Viguerie,
edited by Mark Jenkins and V. Ambrosini, Palgrave, 3rd ‘Strategy under uncertainty’, Harvard Business Review,
edition, 2015. vol. 75, no. 6 (1997), pp. 67–79.
8. R.S. Burt, M. Kilduff and S. Tasselli, ‘Social network 18. R.A. Slaughter, ‘Looking for the real megatrends’,
analysis: foundations and frontiers on advan- Futures, October (1993), pp. 823–49.
tage’, Annual Review of Psychology, vol. 64 (2013), 19. A. Grove, Only the Paranoid Survive, Profile Books,
pp. 527–47; R.S. Burt and G. Soda, ‘Social Origins of 1998.

57
Chapter 2 Macro-environment analysis

20. S. Mendonca, G. Caroso and J. Caraca, ‘The strategic 22. Based on P. Schoemaker, ‘Scenario planning: a tool for
strength of weak signals’, Futures, 44 (2012), pp. 218–28; strategic thinking’, Sloan Management Review, vol. 36
and P. Schoemaker and G. Day, ‘How to make sense of (1995), pp. 25–34.
weak signals’, Sloan Management Review, vol. 50, no. 3 23. www.shell.com/global/future-energy/scenarios/
(2009), pp. 81–9. new-lens-scenarios.html
21. For a discussion of scenario planning in practice, see 24. G. Tziralis and I. Tatsiopoulos, ‘Prediction markets: An
R. Ramirez, S. Churchhouse, A. Palermo and J. Hoff- extended literature review’,The Journal of Prediction
mann, ’Using scenario planning to reshape strategy’, Markets, vol.1, no. 1 (2012), pp. 75–91; K. Matzler, C. Grabher,
MIT Sloan Management Review, vol. 58, no. 4 (2017), J. Huber and J. Füller, ‘Predicting new product success with
pp. 31–37. For how scenario planning fits with other prediction markets in online communities’, R&D Manage-
forms of environmental analysis such as PESTEL, see ment, vol. 43, no. 5 (2013), pp. 420–32.
G. Burt, G. Wright, R. Bradfield and K. van der Heijden, 25. P. Wlodarczak, ‘An Approach for big data technologies
’The role of scenario planning in exploring the in social media mining’, Journal of Art Media and Tech-
environment in view of the limitations of PEST and its nology, vol. 1, no. 1 (2015), pp. 61–66.
derivatives’, International Studies of Management and
Organization, vol. 36, no. 3 (2006), pp. 50–76.

58
 Alibaba: the Yangtze River Crocodile

Case example
Alibaba: the Yangtze River Crocodile
Richard Whittington
Jack Ma and colleagues had launched Alibaba in 1999
as China’s first business-to-business portal connecting
domestic manufacturers with overseas buyers. Since
then, the Group has grown in many directions. 1688.com
was founded for business-to-business trade within China.
Alibaba’s Taobao Marketplace serves small businesses and
individuals. Tmall.com provides electronic shop fronts to
help overseas companies such as Nike, Burberry and
Decathlon to reach Chinese consumers. Juhuasuan offers
daily deals on everything from toys to laptops. Behind
all this are Alibaba’s enormous server farms, which form
the basis for another market-leading business, cloud
computing. There is also Alipay, effectively under Ma’s
Jack Ma, founder of Alibaba. personal control but functioning as the Group’s equivalent
Source: Eugenio Loreto/EPA-EFE/Shutterstock to PayPal, which processes most Group transactions. One
way or another, it is possible for Alibaba’s customers to
In late 2018, Jack Ma, founder of China’s largest trade almost anything: the American security services have
e-commerce company Alibaba, announced shock news: in even set up a sting operation on Alibaba to catch traders
the coming year, he would step aside as company Chairman selling uranium to Iran. In 2018, Alibaba had approaching
in favour of the Chief Executive, Daniel Zhang. Jack Ma had 58 per cent of the e-commerce market in China, the largest
been Alibaba’s charismatic leader for two decades. But Ma e-commerce market in the world. In 2015, Alibaba had
made it clear that he was not disappearing altogether: he invested in the Indian e-commerce business Snapdeal and
remained a major shareholder and would be a permanent the following year it bought a majority stake in the Singa-
member of the 36 strong ‘partnership’ that nominated pore e-commerce business, Lazada. The company also
the majority of the company’s board of directors. A senior had strong positions in Brazil and Russia. International
banking analyst observed of Ma: ‘He has been the spiritual e-commerce represented nearly 7 per cent of the
leader of the company since he founded it, and everyone company’s sales in the last quarter of 2018 (about $1,247m
looks up to him. People call him Teacher Ma. That means out of total quarterly sales of $17,057m: see also Table 1).
people are not looking at him as manager or chief execu- Alibaba had always had an international bent. Jack
tive or chairman – they are looking to him for guidance.’ Ma had started his career as an English language teacher
The new Chairman and Chief Executive Daniel Zhang in the city of Hangzhou, capital of the prosperous prov-
was more of a professional manager than the entrepre- ince of Zhejiang and not very far from Shanghai. Ma had
neurial Ma. Educated in China, he had begun his career discovered the Internet on his trips to the United States in
in the accounting firms Arthur Andersen and PwC before the mid-1990s. As early as 2000, Ma had persuaded both
joining Alibaba in 2007. One of Zhang’s great successes the leading American investment bank Goldman Sachs
at Alibaba had been the idea of making Singles’ Day in and the Japanese internet giant Softbank to invest. The
November a national festival of shopping, all served then ascendant American internet company Yahoo had
by Alibaba’s online commerce businesses of course. bought nearly a quarter of the Group in 2005. Even after
Recently Zhang has rolled out Singles’ Day internationally, Alibaba went public in 2015, SoftBank still held 32.4 per
backed by his experience in international firms. During a cent of the shares and Yahoo 15 per cent. The Alibaba
company-wide strategy session soon after becoming Chief Group board counted as members Yahoo’s founder Jerry
Executive in 2015, he said: ‘We must absolutely globalize. Yang, Softbank’s founder Masayoshi Son and Michael
We will organize a global team and adopt global thinking Evans, former vice-chairman of Goldman Sachs. Even so,
to manage the business and achieve the goal of global buy Jack Ma was ambivalent about Western investors: ‘Let
the Wall Street investors curse us if they wish!’, Ma had
and global sell.’

59
Chapter 2 Macro-environment analysis

Table 1 Key statistics

2010 2012 2014 2015 2016 2017 2018

Alibaba Group Sales Yuan bn 6.7 20.0 52.5 76.2 101.1 158.3 250.3

Chinese GDP Yuan Tr. 40.4 53.4 64.4 68.9 74.4 82.7 90.0

Chinese online retail sales Yuan Tr. 0.5 1.3 2.8 3.9 5.2 7.2 n.a.

Per cent of Chinese using Internet 34.3 41.0 46.0 50.3 52.2 55.8 n.a.

Sources: Statistical Report on Internet Development in China; InternetLiveStats.com; Statista.com. One Yuan = €0.13; $0.15; £0.11.

proclaimed at a staff rally. ‘We will still follow the principle has also allied with several so-called ‘princelings’, children
of customers first, employees second and investors third!’ of important political leaders. Princeling investors include
Strictly, overseas investors do not directly own stakes Winston Wen, son of a former Chinese premier; Alvin
in the Alibaba Group, instead owning shares in a shell Jiang, grandson of a former Chinese President; He Jinlei,
company – a so-called variable interest entity (VIE) – that son of a former Politburo member and a senior manager
has a contractual claim on Alibaba’s profits. This VIE struc- of the state Chinese Development Bank; and Jeffrey Zang,
ture is a common way for Western-listed Chinese firms to get son of a former vice premier and a senior manager at
around Beijing’s foreign-ownership rules. But the Chinese China’s state sovereign wealth fund, Citic Capital.
government could close the loophole at any time, and it Given Chinese President Xi Jinping’s sweeping political
gives foreign shareholders limited recourse against abuses and economic reform campaign, there are no guarantees
by Chinese companies’ managers. Ironically, the most notor- of Alibaba’s position domestically. In 2015, princeling
ious VIE controversy so far involved Alibaba’s Jack Ma, who investor He Jinlei’s older brother was placed under house
in 2011 separated Alipay from the rest of the Group without arrest because of accusations of corruption. 2015 had also
board approval. Ma said new Chinese regulations forced him seen the publication of an investigation by China’s State
to make the move. Yahoo was only told about the spin-off Administration for Industry and Commerce into counter-
five weeks after it had happened. A fundraising round for feit goods and fake listings on the Group’s Taobao site,
Alipay’s new parent company valued Alipay at nearly $50bn. leading to a 10 per cent fall in Alibaba’s share price. Jack
Jack Ma cultivated important relationships within China Ma commented on his relations with Chinese regulators:
as well as abroad. Early on he socialised with a group of ‘Over the past two years, not only was I a very controver-
businessmen known as the Zhejiang Gang, because of sial figure, but also these days, the disputes are bigger
their common roots in the province whose capital was and bigger.’ He continued, ‘I, too, felt puzzled, sometimes
Ma’s home city of Hangzhou. Prominent members of this wronged – how did things become this way?’ Nonetheless,
group included some of China’s most successful entrepren- Ma promised to clean up the site. In 2018, in an apparent
eurs: for example, Guo Guangchang of the huge divers- reproof, Chinese state media let out the news, previously
ified Fosun Group; Shen Guojun of China Yintai Holdings, withheld, that Jack Ma was a longstanding member of the
a retail property developer; and Shi Yuzhu, of the online Chinese Communist Party.
gaming company Giant Interactive. President Xi Jinping’s reform campaigns were partly
Alibaba’s relationship with the Chinese government is in response to changing economic conditions in China.
hard to read. Jack Ma insists that he has never taken loans After three decades of double-digit growth, China’s
or investment from the Chinese government or its banks: growth rate has slowed to around 7 per cent a year more
he had gone to overseas investors instead. However, given recently (see Table 1). Such growth is very respectable
that a third of Chinese business activity is carried out by world standards. Besides, faced with rising domestic
within state-owned enterprises, the government is bound concern about the environment, President Xi was happy
to be in close liaison with the dominant national player in to restrain the expansion of high polluting industries such
e-commerce. Ma explained his philosophy as: ‘Always try to as cement, coal and steel. At the same time, the Chinese
stay in love with the government, but don’t marry them.’ government was promoting e-commerce as a key area for
The Alibaba Group has built up its political connections. future economic growth. However, there were causes for
Tung Chee-hwa, Hong Kong’s first chief executive after its concern. Many local authorities and firms had borrowed
return to China, served on its board of directors. Alibaba heavily on expectations of higher growth, and there

60
 Alibaba: the Yangtze River Crocodile

were fears that financial institutions had over-lent. Some codes with their smartphone cameras to make instant
warned of a consequent crash. Moreover, it was hard to purchases through JD.com. Mobile commerce is increas-
see China’s growth rate picking up again, on account of ingly important in China, with 788 million people being
an aging population and the drying up of the traditional mobile users, 98 per cent of the country’s total user base
supply of young labour from rural villages: the Chinese in 2017. Mobile has been a challenge for Alibaba’s tradi-
labour force participation rate has dropped from a high tional PC-based retail model, but the company has been
of 79 per cent in 1990 to 69 per cent by 2017. Although catching up with about 80 per cent of its e-commerce
the government relaxed the famous one-child per family business on mobile devices by 2017.
rule in 2013, Chinese parents are still reluctant to have In a context of slower Chinese growth and increased
more children because of the cost of housing and good domestic competition, the internationalisation strategy
education in the main urban centres. It is predicted that by of Alibaba’s new Chairman Daniel Zhang seemed to make
the early 2030s, about a quarter of China’s population will sense. However, Zhang faced one major challenge: resist-
be over 65 (against 17 per cent in the United Kingdom). ance in the world’s second largest e-commerce market,
Slower economic growth in China overall is being the United States. In January 2017, the first month of the
matched by a slowing in the rate of growth of the Chinese new American Presidency, Jack Ma had met Donald Trump
e-commerce market (see Table 1). in New York and promised that Alibaba’s investment
At the same time, Alibaba faces greater competition in the United States would bring one million new jobs
in its home market. A decade ago, Alibaba had seen off to America. Alibaba invested in two large data centres
an attack by American rival eBay in the Chinese market for its expanding cloud computing business. However,
with a fierce price-war. Jack Ma had proclaimed: ‘EBay is the United States was the home of Amazon, Micro-
a shark in the ocean; we are a crocodile in the Yangtze soft and Google, all with vast cloud businesses of their
River. If we fight in the ocean, we will lose, but if we own. Besides, nationalist Donald Trump was imposing
fight in the river, we will win.’ A combination of cultural, boycotts on Chinese technology companies and threat-
linguistic and government policy factors kept Western ening tariffs. At the end of 2018, Alibaba announced the
internet companies at arm’s length in the Chinese winding down of its cloud computing operations in the
market: Google has been reduced to a market share of United States. For the Yangtze River crocodile, attacking
about 1 per cent, while Amazon eventually chose to list the ocean sharks in their home seas may have been a step
on Alibaba’s TMall site after a decade pushing its own too far.
venture in China. Main case sources: China Daily, 8 and 13 May 2015; Financial Times,
But now Alibaba’s home-market dominance is facing 9 September 2014 and 14 September 2018; South China Morning Post,
a local challenge from the aggressive JD.com. JD.Com’s 12 February 2015; Washington Post, 23 November 2014; Wall Street
Journal, 4 December 2018.
founder and chief executive Richard Liu has declared a
goal of beating Alibaba to the top position: ‘The compe-
tition makes the two companies stronger. I’m actually
enjoying competing.’ While Alibaba depended for a long
time on China’s unreliable postal service to get its goods Questions
to customers’ doors, JD.com has been more like Amazon 1 Carry out a PESTEL analysis of Alibaba at the time of the
in investing heavily in its own distribution centres and case. Evaluate the balance of opportunities and threats,
delivery services. By 2018, JD.com had 16.3 per cent of using the same kind of figure as in Illustration 2.1.
China’s e-commerce market. Tencent, China’s largest 2 Draw a basic sociogram of Alibaba’s network (see
social networking and online games company, has taken Section 2.2.3 and Figure 2.5): some simplification may
a 15 per cent stake in JD.com, giving the challenger access be necessary. Explain why Alibaba’s network might be
to more than 890 million users of its WeChat phone useful.
messaging app. WeChat allows users to scan product bar

61
Chapter 3
Industry and sector analysis

Key terms Learning outcomes

Blue Oceans 85 After reading this chapter you should be able to:
complementor 71 • Define industries and use Porter’s competitive five forces
critical success factors 84 framework to analyse industries or sectors: rivalry, threat of
industry 63 entrants, substitute threats, customer’s power and supplier
power.
market 63
• On the basis of the five competitive forces, define industry
market segment 83 attractiveness and identify how the forces can be managed.
network effects 71 • Understand different industry types and how industries
Porter’s Five Forces develop and change in industry life cycles and how to make
Framework 64 five force analyses dynamic through comparative industry
strategic groups 80 structure analysis.

strategy canvas 84 • Analyse strategic and competitor positions in terms of

strategic groups, market segments and the strategy canvas.
• Use these various concepts and techniques together with
those from Chapter 2 in order to recognise threats and
opportunities in the industry and marketplace.

Macro-
environment

Industry I Stakeholders
Strategic
position

Resources Culture
 3.1 Introduction

3.1 Introduction
In the last chapter we considered how the broad macro-environment influences opportu-
nities and threats. The impact of these general factors tends to surface in the immediate
environment of the specific industry or sector and this nearby environment is the focus of this
chapter. For example, Samsung’s strategy depends on the smartphone industry: here it must
take account of competitors’ strategies, customers’ needs, and the supply of phone compo-
nents, for example microchips. Similarly, a hospital needs to consider actors in the healthcare
sector including clients, other healthcare providers and the supply of healthcare inputs such as
pharmaceuticals. This suggests that it is crucial for managers to carefully examine the industry
or sector and the actors these involve carefully in order to determine what strategy to pursue.
The focus here is thus on the middle ‘industry’ and ‘sector’ layer in Figure 2.1 (see page 35),
which involves central actors that influence an organisation’s long-term survival and success
including competitors, customers or clients, and suppliers. An industry is a group of firms
producing products and services that are essentially the same.1 Examples are the auto-
mobile industry and the airline industry. Industries are also often described as ‘sectors’,
especially in public services (e.g. the health sector or the education sector). Industries
and sectors are often made up of several specific markets or market segments. A market
is a group of customers for specific products or services that are essentially the same
(e.g. a particular geographical market). Thus, the automobile industry has markets in North
America, Europe and Asia, for example.
This chapter examines three main topics and provides different frameworks and concepts
for understanding the industry or sector:

• Industry analysis through the use of the Competitive Five Forces Framework, which exam-
ines five essential industry forces: competitors, customers, potential entrants, suppliers
and substitutes. One additional factor is complementors and the related phenomenon
network effects. Together these forces and factors provide an understanding of industry
attractiveness and competitive strategy.
• Fundamental industry structures and dynamics, which include examinations of underlying
economic industry types and how industries evolve through industry life cycles, which might
influence changes in the five forces that can be examined with a comparative five force analysis.
• Competitor groups and segments including examinations of strategic groups, groups of
organisations with similar strategies and of market segments, groups of customers with
similar needs. This focus provides a more fine-grained understanding of competition
within an industry or sector.

The structure and topics of this chapter are summarised in Figure 3.1.

Figure 3.1 Industry and sector environments: the key topics

Industry analysis

Industry types and dynamics

Competitor groups and segments

63
Chapter 3 Industry and sector analysis

3.2 Industry analysis

Industries vary widely in terms of their long-term attractiveness, as measured by how easy
it is for participating firms to earn high profits. A key determinant of profitability is the
extent of competition and the strength of buyers and suppliers and this varies between
industries. Where competition and buyer and supplier strengths are low, and there is little
threat of new competitors, participating firms should normally expect good profits. Prof-
itability between industries can thus vary considerably; for example, the pharmaceutical
industry has performed very well historically while others, like the airline industry, have
underperformed.2
Porter’s Five Forces Framework 3 assists industry analysis and helps to identify
industry attractiveness in terms of five competitive forces: (i) extent of rivalry
between competitors; (ii) threat of entry; (iii) threat of substitutes; (iv) power of
buyers; and (v) power of suppliers. These five forces together determine an industry’s
‘structure’ and its attractiveness (see Figure 3.2). Once this has been understood, the
five forces can help set an agenda for action on various critical issues: for example, what

Figure 3.2 The Five Competitive Forces Framework

Potential
entrants

Threat of
entry

Competitive
Suppliers Buyers
rivalry
Bargaining Bargaining
power power

Threat of
substitutes

Substitutes

Source: Adapted from Competitive Strategy: Techniques for Analyzing Industries and Competitors by Michael E.
Porter, copyright © 1980, 1998 by The Free Press. All rights reserved.

64
 3.2 Industry analysis

specific strategy to pursue in order to control excessive rivalry in a particular industry?

Managers should try to find positions where the organisation can best defend itself
against strong competitive forces or where they can influence them in its favour. The rest
of this section first discusses how to define the scope of an industry and then introduces
each of the five forces in more detail and discusses the implications of these for strategy.
Illustration 3.3 (see page 74) summarises industry and sector analysis and provides an
overview of its various steps.

3.2.1 Defining the industry

One of the primary issues for managers is to identify the arena of competition. The first
step in an industry analysis is thus to define the industry. If defined incorrectly there is a
risk that significant strategy aspects are overlooked. There are three fundamental issues to
consider here. First, and most generally, the industry must not be defined too broadly or
narrowly. For example, if an entrepreneur considers starting a taxi business in Stockholm and
makes an industry analysis it would be much too broad to define the industry as ‘the Swedish
personal transportation industry’ while ‘the minicab industry in central Stockholm’ would be
too narrow. The first definition would include such a wide variety of actors that the analysis
risks becoming meaningless, while the second risks excluding important competitors (e.g.
taxi firms from the suburbs).
Secondly, the broader industry value chain needs to be considered. Different industries
often operate in different parts of a value chain or value system and should be analysed
separately (see Section 4.4.2 for a discussion of value systems). For example, the iron ore
industry (including companies like Vale, Rio Tinto and BHP Billiton) delivers to the steel manu-
facturing industry (including companies like Mittal Steel and Tata Steel) that in turn deliver
to a wide variety of industries such as automobiles and construction. These three stages in
the broader value chain or system should be analysed separately.
Thirdly, most industries can be analysed at different levels, for example different geogra-
phies, markets and even different product or service segments within them (see Section 3.4.2
below). Thus, the airline industry has different geographical markets (Europe, China and
so on) and it also has different service segments within each market (e.g. leisure, business
and freight). The competitive forces are likely to be different for each of these markets and
segments, with distinct buyers, suppliers and barriers, etc. Michael Porter has his own rule
of thumb here and suggests that you are likely dealing with distinct industries if there are
differences between them in more than one competitive force, or where differences in any
force are large. In brief, it is important to consider both to what extent a market is national,
regional or global (see Section 9.4 for a discussion of degree of internationalisation) and if
product and service segments differ.
Larger corporations are often organised based on diverse markets and segments and
would thus analyse each separately. For example, Electrolux, the Swedish appliance manu-
facturer, organises its major appliances (refrigerators, washing machines, etc.) in regional
geographical markets, but also has two global business segments (small appliances and
professional products) and would analyse all these separately. The specific strategy ques-
tion or organisation at issue might also provide a good indication of how to define the
industry. Sometimes there is no ideal way of drawing the industry boarders. Under these
circumstances the important thing is to draw the industry borders clearly. They must be
drawn consistently when it comes to what actors are inside and outside the industry. In
particularly complex cases it might be necessary to try out both narrower definitions to
identify details and broader ones to avoid overlooking important actors. Finally, industry
borders may change over time depending on macro-environment changes and moves by
competitors (as discussed below in Section 3.3.2).

65
Chapter 3 Industry and sector analysis

3.2.2 The competitive forces

Porter’s main message is that where the competitive five forces are strong, industries are not
attractive to compete in. Excessive competitive rivalry, powerful buyers and suppliers and
the threat of substitutes or new entrants will all combine to squeeze profitability. Although
initially developed with businesses in mind, the Five Forces Framework is relevant to most
organisations. It can provide a useful starting point for strategic analysis even where profit
criteria may not apply. In the public sector, it is important to understand how powerful
suppliers can push up costs; in the charity sector it is important to avoid excessive rivalry
within the same sector and market. Not-for-profits may also want to consider how likely a
grant provider for an organisation or member of a charity organisation would substitute for
someone else providing similar services.
It’s important to keep in mind that the whole industry is in focus when making a five
forces analysis rather than an individual firm or group of firms. It often makes sense to start
the analysis with rivalry as it defines the various core players from the very beginning and
this is thus discussed first below.

Competitive rivalry
At the centre of five forces analysis is the rivalry between the existing players – ‘incumbents’ –
in an industry. The more competitive rivalry there is, the worse it is for incumbents. Compet-
itive rivals are organisations aiming at the same customer groups and with similar products
and services (i.e. not substitutes). In the European airline industry, Air France and British
Airways are rivals; high-speed trains are a ‘substitute’ (see below). Five factors tend to define
the extent of rivalry in an industry or market:

• Competitor concentration and balance. Where competitors are numerous or of roughly

equal size or power there is the danger of intensely rivalrous behaviour as competitors
attempt to gain dominance over others, through aggressive price cuts for example.
Conversely, less rivalrous industries tend to have one or two dominant organisations,
with the smaller players reluctant to challenge the larger ones directly (e.g. by focusing
on niches to avoid the ‘attention’ of the dominant companies).
• Industry growth rate. In situations of strong growth, an organisation can grow with the
market, but in situations of low growth or decline, any growth is likely to be at the expense
of a rival and meet with fierce resistance. Low-growth markets are therefore often associ-
ated with price competition and low profitability. The industry life cycle influences growth
rates, and hence competitive conditions (see Section 3.3.2).
• High fixed costs. Industries with high fixed costs, perhaps because they require high invest-
ments in capital equipment or initial research, tend to be highly rivalrous. Companies
will seek to spread their fixed costs (i.e. reduce unit costs) by increasing their volumes: to
do so, they typically cut their prices, prompting competitors to do the same and thereby
triggering price wars in which all competitors in the industry suffers. Similarly, if extra
capacity can only be added in large increments (as in many manufacturing sectors, for
example a chemical or glass factory), the competitor making such an addition is likely to
create short-term overcapacity in the industry, leading to increased competition to use
capacity.
• High exit barriers. The existence of high barriers to exit – in other words, high closure or
disinvestment costs – tends to increase rivalry, especially in declining industries. Excess
capacity persists and consequently incumbents fight to maintain market share. Exit barriers

66
 3.2 Industry analysis

might be high for a variety of reasons: for example, high redundancy costs or high invest-
ment in specific assets such as plant and equipment which others would not buy.
• Low differentiation. In a commodity market, where products or services are poorly differenti-
ated, rivalry is increased because there is little to stop customers switching between compet-
itors and the only way to compete is on price. Petrol is a commodity market, for instance.

The threat of entry

How easy it is to enter the industry influences the degree of competition. The greater the
threat of entry, the worse it is for incumbents in an industry. An attractive industry has high
barriers to entry that reduce the threat of new competitors. Barriers to entry are the factors
that need to be overcome by new entrants if they are to compete in an industry. Illustra-
tion 3.1 describes the entry barriers into the banking industry and the obstacles they provide
for new entrants. Five important entry barriers are:

• Scale and experience. In some industries, economies of scale are extremely important: for
example, in pharmaceuticals where there are extremely high fixed costs for extensive R&D
and marketing that must be spread over high levels of output (see Chapter 7 for further
details on economies of scale). Once incumbents have reached large-scale production, it will
be very expensive for new entrants to match them and until they reach a similar volume
they will have higher unit costs. Barriers to entry also come from experience curve effects
that give incumbents a cost advantage because they have learned how to do things more
efficiently than an inexperienced new entrant could possibly do (see Section 7.3.1). Until the
new entrant has built up equivalent experience over time, it will tend to produce at higher
cost. In addition to these supply-side economies of scale there are ‘demand or buyer side’
economies of scale, or so called network effects in some industries, as buyers value being in a
’network’ of a large number of other customers (see Section 3.2.3 below for further details).
• Access to supply or distribution channels. In many industries incumbents have had control
over supply and/or distribution channels. Sometimes this has been through direct owner-
ship (vertical integration), sometimes just through customer or supplier loyalty. In some
industries this barrier has been overcome by new entrants who have bypassed retail
distributors and sold directly to consumers through e-commerce (e.g. Dell Computers
and Amazon). Similarly, incumbents may have cost or quality advantages not available to
entrants, including access to proprietary technology (e.g. patents), geographical locations
or brand identity (e.g. Coca Cola).
• Capital requirements. The level of financial resources needed to enter an industry can
prevent entry. To enter the pharmaceutical industry, for example, huge research and
development investments over many years are needed. While large corporations may
have access to the capital needed it may limit the number of likely entrants.
• Legislation or government action. Legal restraints on new entry vary from patent protec-
tion (e.g. pharmaceuticals), to regulation of markets (e.g. pension selling), through to
direct government action (e.g. tariffs). Of course, organisations are vulnerable to new
entrants if governments remove such protection, as has happened with deregulation of
the airline industry over the last couple of decades.
• Expected retaliation. If an organisation considering entering an industry believes that
the retaliation of an existing firm will be so great as to prevent entry, or mean that entry
would be too costly, this is also a barrier. Retaliation could take the form of a price war or
a marketing blitz. Just the knowledge that incumbents are prepared to retaliate is often
sufficiently discouraging to act as a barrier.

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Chapter 3 Industry and sector analysis

Illustration 3.1 Busted banking barriers?

The barriers to entry into the retail banking industry have traditionally been very
high, but there are signs they could possibly be tumbling.

The high barriers to entry in financial services include structural prospective banks, which has led to twelve new banks
barriers due to basic industry conditions such as economies of now authorised since April 2013.’
scale, network effects and regulation. The latter is significant
It remains to be seen if competition will increase, but
in this particular industry; to protect the safety and stability
adding to the regulators’ efforts is a new breed of potent
of the financial system there are high regulatory walls. While
rivals that may prove more powerful. Helped by new IT
incumbents may complain as authorities introduce new regu-
technologies, software and mobile banking there are over
lations, they often promote them once they adapted to them
a hundred so-called ‘fintech’ (finance and technology)
as regulations raise barriers for new entrants. Hence, they tend
start-ups, as confirmed in a Deloitte report:
to exploit and lobby for structural regulation barriers to their
own advantage to keep competitors out. ‘New, agile and hitherto unregulated players are
In the UK regulative and other barriers have resulted in emerging and are disintermediating the traditional
the ‘Big Five’ domination: HSBC, Barclays, Royal Bank of Scot- incumbents [reducing the use of intermediaries between
land, Lloyds and Santander. Other markets are very similar banks and consumers].’
with a ‘Big Five’ in Canada, ‘Big Threes’ in Spain and the
Netherlands and a ‘Big Four’ in Sweden. In the aftermath of Even if incumbent banks also try to jump on this fintech
the 2008 financial crisis regulations have increased further. bandwagon they may not be able to dominate it. In contrast
The dilemma for regulators is that they have two partly to the flourishing fintech start-ups they are often bound by
conflicting objectives. First, to secure the stability of the current regulations as the report continued:
financial system they need to have capital requirements and
other strict regulations for banks. The second aim is to deliver ‘Regulation is making it harder to innovate and grow,
more efficiency and more services for customers through whilst legacy strategy, infrastructure and thinking, are
increased competition. To act on this second objective regu- preventing the existing players from responding aggres-
lators have started to encourage more entrants and assist sively from this threat’.
them to find cracks in the barriers without totally breaking
them. For example, Managing Director of Britain’s Payment Sources: E. Robinson, BloombergBusiness, 16 February 2016; H. Jones,
Systems Regulator, Hannah Nixon, proposes: Reuters, 25 February 2016; Financial Conduct Authority, 20 January
2016; J. Cumbo, Financial Times, 6 December 2015.
‘There needs to be a fundamental change in the industry
to encourage new entrants to compete on service, price
and innovation in an open and transparent way.’ Questions
UK’s financial regulators have even launched a start-up 1 Evaluate the strengths of the banking industry’s entry
unit to help new players to enter, as Andrew Bailey, former barriers according to Porter’s criteria.
CEO of the Prudential Regulation Authority, explained: 2 How would you evaluate the behaviour of banks
trying to keep competition out from an ethical point
‘The New Bank Start-Up Unit builds on the work we
of view?
have already done to reduce the barriers to entry for

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 3.2 Industry analysis

The threat of substitutes

Substitutes are products or services that offer the same or a similar function and benefit to an
industry’s own products or services, but have a different nature. For example, aluminium is a
substitute for steel; a tablet computer is a substitute for a laptop; charities can be substitutes
for public services. Managers often focus on their competitors in their own industry, and
neglect the threat posed by substitutes. Substitutes can reduce demand for a particular type
of product as customers switch to alternatives – even to the extent that this type of product
or service becomes obsolete. However, there does not have to be much actual switching for
the substitute threat to have an effect. The simple risk of substitution puts a cap on the prices
that can be charged in an industry. Thus, although Eurostar trains has no direct competitors
in terms of train services from Paris to London, the prices it can charge are ultimately limited
by the cost of flights between the two cities.
There are two important points to bear in mind about substitutes:

• Extra-industry effects are the core of the substitution concept. Substitutes come from
outside the incumbents’ industry and should not be confused with competitors’ threats
from within the industry. The value of the substitution concept is to force managers to
look outside their own industry to consider more distant threats and constraints. If the
buyers’ switching costs for the substitute are low the threat increases. The higher the
threat, the less attractive the industry is likely to be.
• The price/performance ratio is critical to substitution threats. A substitute is still an
effective threat even if more expensive, so long as it offers performance advantages
that customers value. Thus aluminium is more expensive than steel, but its relative
lightness and its resistance to corrosion give it an advantage in some automobile manu-
facturing applications. It is the ratio of price to performance that matters, rather than
simple price.

The power of buyers

Buyers are the organisation’s immediate customers, not necessarily the ultimate consumers.
If buyers are powerful, then they can demand low prices or costly product or service
improvements.
Buyer power is likely to be high when some of the following four conditions prevail:

• Concentrated buyers. Where a few large customers account for the majority of sales, buyer
power is increased. This is the case for items such as milk in the grocery sector in many
European countries, where just a few retailers dominate the market. If a product or service
accounts for a high percentage of total purchases of the buyer their power is also likely
to increase as they are more likely to ‘shop around’ to get the best price and therefore
‘squeeze’ suppliers more than they would for more trivial purchases.
• Low switching costs. Where buyers can easily switch between one supplier and another,
they have a strong negotiating position and can squeeze suppliers who are desperate
for their business. Switching costs are typically low for standardized and undifferentiated
products commodities such as steel. They are also likely to be low when the buyers are
fully informed about prices and product performance.
• Buyer competition threat. If the buyer has the capability to supply itself, or if it has the
possibility of acquiring such a capability, it tends to be powerful. In negotiation with its
suppliers, it can raise the threat of doing the suppliers’ job themselves. This is called back-
ward vertical integration (see Section 8.5), moving back to sources of supply, and might
occur if satisfactory prices or quality from suppliers cannot be obtained. For example, some

69
Chapter 3 Industry and sector analysis

steel companies have gained power over their iron ore suppliers as they have acquired
iron ore sources for themselves.
• Low buyer profits and impact on quality. For industrial or organisational buyers there are two
additional factors that can make them price sensitive and thus increase their threat: first, if
the buyer group is unprofitable and pressured to reduce purchasing costs and, second, if
the quality of the buyer’s product or services is little affected by the purchased product.

It is very important that buyers are distinguished from ultimate consumers. Thus for
companies like Procter & Gamble or Unilever (makers of shampoo, washing powders and
so on), their buyers are retailers such as Carrefour or Tesco, not ordinary consumers. Carre-
four and Tesco have much more negotiating power than an ordinary consumer would
have. The high buying power of such supermarkets is a strategic issue for the companies
supplying them. It is often useful therefore to distinguish ‘strategic customers’, powerful
buyers (such as the retailers) towards whom the strategy should be primarily orientated.
In the public sector, the strategic customer is typically the provider of funds, rather than
the consumer of services: for a pharmaceutical company, the strategic customer is the
hospital, not the patient.

The power of suppliers

Suppliers are those who supply the organisation with what it needs to produce the product
or service. As well as fuel, raw materials and equipment, this can include labour and sources
of finance. The factors increasing supplier power are the converse to those for buyer power.
Thus supplier power is likely to be high where there are:

• Concentrated suppliers. Where just a few producers dominate supply, suppliers have more
power over buyers. The iron ore industry is now concentrated in the hands of three main
producers, leaving the steel companies, still relatively fragmented, in a weak negotiating
position for this essential raw material.
• High switching costs. If it is expensive or disruptive to move from one supplier to another,
then the buyer becomes relatively dependent and correspondingly weak. Microsoft is
a powerful supplier because of the high switching costs of moving from one operating
system to another. Buyers are prepared to pay a premium to avoid the trouble, and Micro-
soft knows it.
• Supplier competition threat. Suppliers have increased power where they are able to enter
the industry themselves or cut out buyers who are acting as intermediaries. Thus airlines
have been able to negotiate tough contracts with travel agencies as the rise of online
booking has allowed them to create a direct route to customers. This is called forward
vertical integration, moving up closer to the ultimate customer.
• Differentiated products. When the products or services are highly differentiated, suppliers
will be more powerful. For example, although discount retailers like Walmart are extremely
powerful, suppliers with strong brands, like P&G with Gilette, still have high negotiating
power. Also, if there is no or few substitutes for the input the supplier group will be more
powerful, like pilots’ unions in the airline industry.

Most organisations have many suppliers, so it is necessary to concentrate the analysis on

the most important ones or types. If their power is high, suppliers can capture all their
buyers’ own potential profits simply by raising their prices. Star football players have
succeeded in raising their rewards to astronomical levels, while even the leading football
clubs – their ‘buyers’ – struggle to make money. Similarly, pilots’ unions have significant
power over airlines.

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 3.2 Industry analysis

3.2.3 Complementors and network effects

Some industries may need the understanding of a sixth factor (or ‘force’), organisations
or companies that are complementors rather than simple competitors. An organisation
is your complementor if it enhances your business attractiveness to customers or
suppliers.4 On the demand side, if customers value a product or service more when they
also have the other organisation’s product there is a complementarity with respect to
customers. For example, app providers are complementors to Apple and other smart-
phone and tablet suppliers because customers value the iPhone and iPad more if there
are a wide variety of appealing apps to download. This suggests that Apple and other
actors in this industry need to take the app providers into consideration when forming
their strategies. On the supply side another organisation is a complementor with respect
to suppliers if it is more attractive for a supplier to deliver when it also supplies the
other organisation. This suggests that competing airline companies, for example, can
be complementary to each other in this respect because for a supplier like Boeing it
is more attractive to invest in particular improvements for two customers rather than
one. Complementarity implies a significant shift in perspective. While Porter’s Five Forces
sees organisations as battling against each other for share of industry value, comple-
mentors may cooperate to increase the total value available. Hence, this suggests that
both value-creating cooperation as well as competition need to be considered in an
industry analysis: this combination of competition and collaboration together is some-
times described as co-opetition.5
Customers may not only value a product more if they also have another product or
service as discussed above, but if other customers use the same product or service. When
this is the case the product or service shows network effects or network externalities.
There are network effects in an industry when one customer of a product or service
has a positive effect on the value of that product for other customers. This implies
that the more customers that use the product, the better for everyone in the customer
network.6 For example, the value of the online auction site eBay increases for a customer
as the network of other sellers and buyers grows on the site. The more goods that are
offered on the site, the better for customers and this makes eBay’s site and services more
attractive to users than smaller competitors. Network effects are very important for
Facebook too (see Illustration 3.2). Network effects can make an industry structurally
attractive with high barriers to entry, low intensity of rivalry and power over buyers as
entrants and rivals can’t compete with other companies’ larger networks and buyers
become locked into them. If these effects are present in an industry they need to be
carefully analysed to understand the industry structure and strategic positioning.7 For
hardware and software computer products the number of users in a network is often
referred to as an ‘installed base’.
In some industries complementors and network effects work in tandem. In the smart-
phone and tablet industries, for example, they operate in two steps. First, app providers
are complementors to Apple as customers are more attracted to the iPhone and iPad if
there are many apps. Second, when more customers are attracted to these products the
network of users grows, which increases the user value even further. For Apple then the
complementary app providers attract more users and this in turn provides for network
effects that attract even further users. Other industries where competitors need to
consider both complementors and network effects are video gaming (e.g. Nintendo) and
computer operation systems industries (e.g. Microsoft). These two latter industries are
sometimes considered to be ‘platform’ businesses and this is discussed in Chapter 7 (see
Section 7.4.2).

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Chapter 3 Industry and sector analysis

Illustration 3.2 Facebook’s network fears

Considering Facebook’s dominance, they should have nothing to fear, but internet
history is littered with fast rising and fast falling social networks.

millions and final collapse. Further back in internet history

there are several other implosions of those with social
network ambitions: BBS, CompuServe, AOL, etc.
Founder and CEO Mark Zuckerberg has, however, seen
the threats and acted. Instagram was acquired in 2012
when it was becoming the biggest mobile photo-sharing
service with many younger users posting content there
rather than on Facebook’s own web-based photo service.
Next was the messaging service WhatsApp: it was bought
in 2014 as users started to move their activities to mobile
platforms. To fence off LinkedIn and Snapchat it launched
‘Workplace’ and ‘Facebook Stories’ respectively. Not even
Google has managed to remove Facebook from the social
networking throne. Google’s first social networking effort
Buzz was based on its Gmail service, but it never managed
to attract enough users. Many Facebook users tried their
next and even bigger bet, Google Plus, but soon discovered
Mark Zuckerberg, Facebook CEO that not many of their friends followed so they returned to
Source: REUTERS/Alamy Stock Photo Facebook.
Facebook remains unbeaten and has perhaps learned
With over 1.75bn users Facebook is not only the largest from social networking history. With its current valuation it
social network globally, but it controls the second, third can possibly continue to make defensive acquisitions when
and seventh largest networks: WhatsApp (1.5bn), Facebook users get attracted to competing platforms, content and
Messenger (1.3bn) and Instagram (1bn). It seems it is well media. But how long will it last? Some question Facebook’s
ahead of everyone else in network effects and has created staying power and claim it’s quite possible it will be over-
high switching costs for users to move to another social taken. Mark Zuckerberg, however, only sees this as inspir-
network. When users have built up a set-up of perhaps ation to build Facebook even stronger:
hundreds of friends and have archives of their whole
‘This is a perverse thing, personally, but I would rather
life including photos they don’t easily switch to another
be in the cycle where people are underestimating us. It
company and network just because it’s something fresh.
gives us latitude to go out and make big bets that excite
Nevertheless, despite Facebook’s clear lead, history
and amaze people.’
shows it’s far from obvious that any social network incum-
bent can stay relevant and dominate long term. Friendster
Sources: Statista 2018; R. Waters, Financial Times, 29 January 2016; J.
pioneered the online community in 2002, three years before Gapper, Financial Times, 12 April 2015; P. Economy, Inc.com, 26 March
Facebook, and gained over three million users within a 2015; A.Liu, digitaltrends.com, 5 August 2014; R. Waters, Financial
year; attracting tens of millions of users at its height. It was, Times, 21 February 2014; J. Gapper, Financial Times, 3 October 2013.
however, soon overtaken by MySpace that appealed to even
more and younger users with their hip features including
music and music videos. By 2008 it was the leading US social Questions
networking site with over 75m users and consistently ahead 1 Why is Facebook so powerful? Would you switch to
of Facebook in traffic. However, soon Facebook started to another social network if it had better features even if it
attract teenagers with its new features with corresponding was considerably smaller?
losses for MySpace. This illustrates that social networks
2 What other social media networks and apps do you use
quickly can gain millions of users and huge valuations, but
that you think could beat Facebook? Why?
can just as quickly face slowing growth, users leaving in

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 3.2 Industry analysis

3.2.4 Implications of the Competitive Five Forces

The Five Forces Framework provides several useful insights into the forces at work in the
industry or market environment of an organisation. The objective is more than simply listing
the strength of the forces and their underlying driving factors. It is rather to determine
whether the industry is a good one to compete in or not and to conclude whether there are
advantageous strategic positions where an organisation can defend itself against strong
competitive forces, can exploit weak ones or can influence the forces in its favour. The aim
of the five forces analysis is thus an assessment of the attractiveness of the industry and any
possibilities to manage strategies in relation to the forces to promote long-term survival
and competitive advantage. As Illustration 3.3 shows, these considerations make up the last
three steps in an industry analysis together with an assessment of industry change, which is
discussed in the next section. When each of the five forces has been evaluated, the next step
is thus to understand the implications of these:

• Which industries to enter (or leave)? One important purpose of the Five Forces Framework
is to identify the relative attractiveness of different industries: industries are attractive
when the forces are weak. In general, entrepreneurs and managers should invest in indus-
tries where the five forces work in their favour and avoid, or disinvest from, markets where
they are strongly unfavourable. Entrepreneurs sometimes choose markets because entry
barriers are low: unless barriers are likely to rise quickly, this is precisely the wrong reason to
enter. Here it is important to note that just one significantly adverse force can be enough
to undermine the attractiveness of the industry as a whole. For example, powerful buyers
can extract all the potential profits of an otherwise attractive industry structure by forcing
down prices. Chapter 8 further examines these strategic choices and corporate strategy and
what to consider when deciding whether to invest into or divest out of various industries.
• How can the five forces be managed? Industry structures are not necessarily fixed but can
be influenced by deliberate managerial strategies. Managers should identify strategic
positions where the organisation best can defend itself against strong competitive forces,
can exploit weak ones or can influence them. As a general rule, managers should try to
influence and exploit any weak forces to its advantage and neutralise any strong ones.
For example, if barriers to entry are low, an organisation can raise them by increasing
advertising spending to improve customer loyalty. Managers can buy up competitors to
reduce rivalry and to increase power over suppliers or buyers. If buyers are very strong,
an organisation can try to differentiate products or services for a specific customer group
and thus increase their loyalty and switching costs. One approach to finding differenti-
ated positions that include weaker forces is ‘Blue Ocean’ thinking, which is discussed in
Section 3.4.3 below. Managing and influencing industry structure involves many issues
relating to strategic choices and business strategy and will be a major concern of Chapter 7.
• How are competitors affected differently? Not all competitors will be affected equally by
changes in industry structure, deliberate or spontaneous. If barriers are rising because of
increased R&D or advertising spending, smaller players in the industry may not be able to
keep up with the larger players and be squeezed out. Similarly, growing buyer power is likely
to hurt small competitors most. Strategic group analysis is helpful here (see Section 3.4.1).

Although originating in the private sector, five forces analysis can have important implications
for organisations in the public and charity sectors too. For example, the forces can be used to
adjust the service offer or focus on key issues. Thus, it might be worth switching focus from
an arena with many crowded and overlapping services (e.g. social work, probation services
and education) to one that is less rivalrous and where the organisation can do something
more distinctive. Similarly, strategies could be launched to reduce dependence on particularly
powerful and expensive suppliers, for example energy sources or high-shortage skills.

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Chapter 3 Industry and sector analysis

Illustration 3.3 Steps in an industry analysis

There are several important steps in an industry analysis before and after analysing
the five forces.

Emily wants to start a coffee shop and perhaps even try to 4 Assess the overall industry structure and attractiveness.
grow the business into several outlets. She needs to consider • How attractive is the industry? Why?
the following steps and questions: • Which are the most important competitive forces?
Which control profitability?
1 Define the industry clearly. Do the actors in the indus-
• Are more profitable competitors better positioned in
try face the same buyers, suppliers, entry barriers and
relation to the five forces?
substitutes?
• Vertical scope: What stages of the industry value For Emily several of the forces are quite strong, but some are
chain/ system? relatively more important for profitability. In addition, some
• Product or service scope: What products or services? competitors, like large coffee chains, are better positioned
Which ones are actually parts of other, separate versus the five forces than others.
industries? What segments?
5 Assess recent and expected future changes for each force.
• Geographic scope: Local, national, regional or global
• What are the potential positive/negative changes?
competition?
How likely are they?
Emily should consider that many diverse businesses serve cof- • Are new entrants and/or competitors changing the
fee. They include not only local cafés and coffee shop chains, industry structure in any way?
but fast food chains, kiosks and restaurants. The definition
For example, Emily needs to consider the proliferation of cof-
also depends on whether Emily intends to start in an urban
fee chains during the last few years and that pubs and baker-
or rural area.
ies have improved their coffee offerings lately. Maybe she can
2 Identify the actors of each of the five forces and, if rele- also spot possible changes in consumer trends and growth.
vant, define different groups within them and the basis
6 Determine how to position your business in relation to
for this. Which are the. . .
the five forces. Can you:
• competitors that face the same competitive forces?
• exploit any of the weak forces?
(compare point 1 above)
• neutralise any of the strong forces?
• buyers and buyer groups (e.g. end customers vs.
• exploit industry change in any way?
intermediaries, individual vs. organisational)?
• influence and change the industry structure to your
• suppliers and supplier groups (e.g. diverse supplier
advantage?
categories)?
• potential entrants? To cope with the forces Emily could possibly identify a concept
• substitutes? that would attract a certain group of customers even if buy-
ers have many choices in urban areas. This could neutralise
Given a clear industry definition the identification of the actors threats from competition and entry somewhat and perhaps
for each force should be rather straightforward for Emily, but provide loyalty from some customers.
groups within them need to be considered. On the supplier
side, for example, they not only include inputs like coffee, but Sources: M.E. Porter, ‘The five competitive forces that shape strategy’,
Harvard Business Review, vol. 86, no. 1, (2008), pp. 58–77; J. Magretta,
also the landlord of the premises and labour supply. Understanding Michael Porter: The Essential Guide to Competition and
Strategy, Harvard Business Review Press, 2012.
3 Determine the underlying factors of and total strength
of each force.
• Which are the main underlying factors for each Questions
force? Why?
• Which competitive forces are strong? Which are 1 Help Emily and go through each step above. Answer
weak? Why? the questions and make a complete analysis. What is
your assessment of the industry?
Not all underlying factors on the five force checklists will be
2 Based on your analysis: How should Emily handle the
equally relevant for Emily. With respect to buyers, for exam-
different forces? What strategic options should she
ple, the products’ degree of standardisation and prices matter
consider?
most, while others are less important.

74
 3.3 Industry types and dynamics

3.3 Industry types and dynamics

The Five Forces Framework is the most well-known strategy tool for industry analysis, but it
has to be used carefully. First, industry types and their underlying economic characteristics
should be considered as they have major implications on industry attractiveness and what
competitive strategies are available. Second, even though industry structures are typically
fairly stable they do change, and some can be in flux for considerable periods of time. This
suggests that basic industry types and industry dynamics in competitive forces need to be
considered. This section thus first examines fundamental industry types and then industry
change and dynamics.

3.3.1 Industry types

The Five Forces Framework builds on theories in economics8 and it helps to identify the main
types of industry structure. They vary from consolidated industries with just one or a few
firms with high profitability to fragmented ones with many, sometimes thousands, firms
with lower profitability (see Table 3.1). In practice, particular industries are typically not pure
representatives of these types, but nonetheless it is helpful to have these broad categories
in mind in order to compare the attractiveness of industries and likely broad patterns of
competitive behaviour within them. Three basic types are:

• Monopoly. A monopoly is formally an industry with just one firm with a unique product or
service and therefore no competitive rivalry. Because of the lack of choice between rivals
and few entrants, there is potentially very great power over buyers and suppliers. This can
be very profitable. Firms can still have monopoly power where they are simply the dominant
competitor: for example, Google has at least 65% market share of the American search
engine market (some sources state 90%), which gives it price-setting power in the internet
advertising market. Some industries are monopolistic because of economies of scale: water
utility companies are often monopolies in a particular area because it is uneconomic for
smaller players to compete. For this reason the government sometimes gives one firm the
right to be the only supplier of a product or service. Other industries are monopolistic
because of ‘network effects’, where a product is more valuable because of the number of
other people using it: Facebook and Microsoft Office are so powerful precisely because so
many are already users.9 See Illustration 3.2 for a discussion of Facebook’s dominance.
• Oligopoly. An oligopoly is where just a few often large firms dominate an industry, with
the potential for limited rivalry and threat of entrants and great power over buyers and

Table 3.1 Industry types

Industry structure Characteristics Competitive five forces threats

Monopoly - One firm Very low

- Often unique product or service
- Very high entry barriers

Oligopoly - Few competitors Varies

- Product and service differences varies
- High entry barriers

Perfect competition - Many competitors Very high

- Very similar products or services
- Low entry barriers

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Chapter 3 Industry and sector analysis

suppliers. With only a few competitors the actions of any one firm are likely highly influ-
ential on the others: therefore all firms must carefully consider the actions of all others.
The iron ore market is an oligopoly, dominated by Vale, Rio Tinto and BHP Billiton. In
theory, oligopoly can be highly profitable, but much depends on the extent of rivalrous
behaviour, the threat of entry and substitutes and the growth of final demand in key
markets. Oligopolistic firms have a strong interest in minimising rivalry between each
other so as to maintain a common front against buyers and suppliers.10 Where there are
just two oligopolistic rivals, as for Airbus and Boeing in the civil airline industry, the situ-
ation is a duopoly.
• Perfect competition. Perfect competition exists where barriers to entry are low, there are
countless equal rivals each with close to identical products or services, and information
about prices, products and competitors is perfectly available. Competition focuses heavily
on price, because products are so similar and competitors typically cannot fund major
innovations or marketing initiatives to make them dissimilar. Under these conditions,
firms are unable to earn more profit than the bare minimum required to survive. Agri-
culture often comes close to perfect competition (e.g. potatoes, apples, onions, etc.) and
so do street food vendors in major cities. Few markets, however, are absolutely perfectly
competitive. Markets are more commonly slightly imperfect so that products can be differ-
entiated to a certain degree and with information not completely available for everyone.
A number of small firm service industries rather have this character, such as restaurants,
pubs, hairdressers, shoe repairs, but also the shampoo, cereal and toothpaste markets.11

It has also been argued that there are ‘hypercompetitive industries’. Hypercompetition
occurs where the frequency, boldness and aggression of competitor interactions accelerate
to create a condition of constant disequilibrium and change.12 Under hypercompetition,
rivals tend to invest heavily in destabilising innovation, expensive marketing initiatives and
aggressive price cuts, with negative impacts on profits. Hypercompetition often breaks out in
otherwise oligopolistic industries. Competitive moves under conditions of hypercompetition
are discussed in Section 7.4.2.
Industry structures change over time and industries can evolve from one type to another,
depending on the macro-environment, the degree of industry maturity and competitive
strategies in the industry with consequences for competitive force strengths. These industry
dynamics are discussed next.

3.3.2 Industry structure dynamics

Industry structure analysis can easily become too static: after all, structure implies stability.13
However, industries are not always stable. To begin with industry borders can change over
time and this needs to be considered when first defining an industry. For example, many
industries, especially in high-tech arenas, are converging. Convergence is where previously
separate industries begin to overlap or merge in terms of activities, technologies, products
and customers.14 Technological change has brought convergence between the telephone,
photographic and the PC industries, for example, as mobile phones have become smart-
phones and include camera and video, e-mailing and document editing functions. Hence,
companies that once were in separate industries, such as Samsung in mobile phones, Sony
in cameras and Apple in computers, are now in the same smartphone industry.
As discussed in the previous chapter the broader macro environment also tends to influ-
ence the more specific industry environment through changes in the industry structure.
These key drivers for change are likely to alter the industry and scenario analyses can be
used to understand possible impacts (see Section 2.4). An illustration of changing industry
structure, and the competitive implications of this, is provided by Illustration 3.4 on the UK

76
 3.3 Industry types and dynamics

charity and public sector. This sub-section examines two additional approaches to under-
standing change in industry structure: the industry life-cycle concept and comparative five
forces analyses.

The industry life cycle

The industry life-cycle concept proposes that industries start small in their development or
introduction stage, then go through a period of rapid growth (the equivalent to ‘adoles-
cence’ in the human life cycle), culminating in a period of ‘shake-out’. The final two stages
are first a period of slow or even zero growth (‘maturity’), and then the final stage of decline
(‘old age’). The power of the five forces typically varies with the stages of the industry life
cycle (see Figure 3.3).15
The development stage is an experimental one, typically with few players, little direct
rivalry and highly differentiated products. The five forces are likely to be weak, therefore,
though profits may actually be scarce because of high investment requirements. The next
stage is one of high growth, with rivalry low as there is plenty of market opportunity for
everybody. Low rivalry and keen buyers of the new product favour profits at this stage,
but these are not certain. Barriers to entry may still be low in the growth stage, as existing
competitors have not built up much scale, experience or customer loyalty. Suppliers can be
powerful too if there is a shortage of components or materials that fast-growing businesses
need for expansion. The shake-out stage begins as the market becomes increasingly satur-
ated and cluttered with competitors (see Illustration 3.4). Profits are variable, as increased
rivalry forces the weakest competitors out of the business. In the maturity stage, barriers
to entry tend to increase, as control over distribution is established and economies of scale
and experience curve benefits come into play. Products or services tend to standardise, with
relative price becoming key. Buyers may become more powerful as they become less avid
for the industry’s products and more confident in switching between suppliers. Profitability
at the maturity stage relies on high market share, providing leverage against buyers and
competitive advantage in terms of cost. The decline stage can be a period of extreme rivalry,

Figure 3.3 The industry life cycle

Development Growth Shake-out Maturity Decline

Market
size

Low rivalry: Low rivalry: Increasing rivalry: Stronger buyers: Extreme rivalry:
High High growth Slower growth Low growth Typically many
differentiation and weak and some exits and standard exits and price
Typical Innovation key buyers, but low Managerial and products, but competition
five forces entry barriers financial strength higher entry Cost and
Growth ability key barriers commitment
key Market share key
and cost key

77
Chapter 3 Industry and sector analysis

especially where there are high exit barriers, as falling sales force remaining competitors into
dog-eat-dog competition. However, survivors in the decline stage may still be profitable if
competitor exit leaves them in a monopolistic position. Figure 3.3 summarises some of the
conditions that can be expected at different stages in the life cycle.
It is important to avoid putting too much faith in the inevitability of life-cycle stages. One
stage does not follow predictably after another. First, industries vary widely in the length
of their growth stages. Many internet-based industries have matured quickly and moved
through the stages in less than a decade, for example online travel and dating services.
Second, some industries can rapidly ‘de-mature’ through radical innovation. Thus, the tele-
phony industry, based for nearly a century on fixed-line telephones, rejuvenated rapidly with
the introduction of mobile and internet telephony. Likewise, since the mobile telephony
handset industry matured it has later been revived by the introduction of smartphones
and smartwatches. Anita McGahan of Toronto University warns of the ‘maturity mindset’,
which can leave many managers complacent and slow to respond to new competition.16
Managing in mature industries is thus not necessarily just about waiting for decline, but
making efforts to reinvent products, services and strategies over time in a potential rejuvena-
tion into a new life cycle. For example, Netflix was active in the DVD rental services industry,
but did not wait for it to decline and die and instead rejuvenated itself as an online movie
and TV show company. It thus now finds itself in a reinvented streaming-content industry
together with Amazon and others. However, even if the various stages are not inevitable,
the life-cycle concept does remind managers that conditions are likely to change over time.
Especially in fast-moving industries, five forces analyses need to be reviewed quite regularly.

Comparative industry structure analyses

The previous section raised the issue of how competitive forces may change over time. The
industry life cycle thus underlines the need to make industry structure analysis dynamic.
This implies that we not only need to understand the current strength of the competitive
forces, but how it may change over time. One effective means of doing this is to compare
the competitive five forces over time in a simple ‘radar plot’.
Figure 3.4 provides a framework for summarising the power of each of the five forces
on five axes. Power diminishes as the axes go outwards. Where the forces are low, the total
area enclosed by the lines between the axes is large; where the forces are high, the total area
enclosed by the lines is small. The larger the enclosed area, therefore, the greater is the profit
potential. In Figure 3.4, the industry at Time 0 (represented by the red lines) has relatively
low rivalry (just a few competitors) and faces low substitution threats. The threat of entry is
moderate, but both buyer power and supplier power are relatively high. Overall, this looks
like only a moderately attractive industry to invest in.
However, given the dynamic nature of industries, managers need to look forward.
Figure 3.4 represents five years forward by the green lines. Managers are predicting in this
case some rise in the threat of substitutes (perhaps new technologies will be developed).
On the other hand, they predict a falling entry threat, while both buyer power and supplier
power will be easing. Rivalry will reduce still further. This looks like a classic case of an industry
in which a few players emerge with overall dominance. The area enclosed by the green lines
is large, suggesting a relatively attractive industry. For a firm confident of becoming one of
the dominant players, this might be an industry well worth investing in.
Comparing the five forces over time on a radar plot thus helps to give industry structure anal-
ysis a dynamic aspect. Similar plots can be made to aid diversification decisions (see Chapter 8),
where possible new industries to enter can be compared in terms of attractiveness. The lines
are only approximate, of course, because they aggregate the many individual elements that
make up each of the forces into a simple composite measure. Notice too that if one of the
forces is very adverse, then this might nullify positive assessments on the other four axes: for
example, an industry with low rivalry, low substitution, low entry barriers and low supplier
78
 3.3 Industry types and dynamics

Illustration 3.4 Consolidation across the UK charity and public

sectors
Consolidating the structure of the UK charity sector and of public sector organisations
may help improve efficiency and services.

The UK charity sector is fragmented with over 180,000 char- their charity’s position in an increasingly volatile sector,
ities including multiple charities for similar causes; 700 char- and plan in the best interest of beneficiaries – could we
ities for blindness, 900 for the armed forces, 500 for animal maximise our reach and impact by joining forces, and
welfare, etc. These charities compete for the same fund- indeed are our services better housed elsewhere?’3
raising and resources and some argue that fragmentation
The public sector is also changing to increase efficien-
has resulted in questionable fund-raising techniques, poor
cies and improve services. One significant merger was the
governance and outdated business processes. It has there-
creation of the Scottish Fire and Rescue Service with a total
fore been proposed that restructuring and consolidation of
budgeted expenditure of £277m. This new national service
the sector is needed to help improve efficiency and services.
for Scotland involved the merger of the eight former local
As stated in a report of the Charity Commission, the regu-
fire authorities. The NHS has also experienced considerable
lator for charities in England and Wales:
consolidation activities. For example, 25 mental health trusts
‘Some people believe that there are too many char- in London have been consolidated into ten that also work in
ities competing for too few funds and that a signif- a network of partnerships with each other.
icant amount of charitable resource could be saved Charity and public sector consolidations are not without
if more charities pooled their resources and worked problems, however, and as with private sector mergers inte-
together. . . ’1 gration difficulties can be severe. Nevertheless, there are
also other forms of collaborations that offer opportunities
Consolidation of charities has started and according to one
to find efficiencies and improved services across charities
report2 there were 129 charities that carried out mergers with
and public sector organisations, for example joint procure-
a transfer of £110m to form new organisations in 2014/15.
ment, sharing facilities, equipment and administration and
While many of the mergers or takeovers are smaller – an
combining different service deliveries to clients.
average of £2.4m income – there have been larger strategic
deals. For example, Addaction (focused on drug and alcohol Sources: 1) ‘RS 4a – Collaborative working and mergers: Summary’,
www.charitycommission.-gov.uk/publications/rs4a.asp; 2) The Good
problems) took mental health provider KCA and Breast
Merger Index, Eastside Primetimers, 2014/15/ and 2013/14; 3) R. Litch-
Cancer Campaign and Breakthrough Breast Cancer joined field, Charity Times, ‘Trustees need more help looking at mergers’, 13
forces. Many small charities are forced into takeovers due to November 2015; 4) Fire and rescue collaboration, Grant Thornton, 26
financial distress because of the overcrowded sector. Leisure March 2014.
trusts have been very active consolidators with three of the
top ten deals, representing 5 per cent of all leisure trusts in
England and Wales. Despite this, consolidation activity is still Questions
at an early stage, as reported in The Good Merger Index:
1 How would you describe the current charity industry
‘The emerging picture is one of a small number of large structure? How could it change if consolidation
transformative mergers, and comparatively long-tail of increases and what would be the benefits and
local small mergers.’2 disadvantages?
‘This shows that trustees aren’t proactively exploring 2 Which of Porter’s five forces are creating problems for
merger and giving their charities space to think strategic- the UK’s charity sector?
ally about the future. Boards should look objectively at

79
Chapter 3 Industry and sector analysis

Figure 3.4 Comparative industry structure analysis

Time 0

Time 5

Rivalry

Low

Entry threat Substitute threat

Low High High Low

High High

High

Low Low

Buyer power Supplier power

power might still be unattractive if powerful buyers were able to demand highly discounted
prices. With these warnings in mind, such radar plots can nonetheless be both a useful device
for initial analysis and an effective summary of a final, more refined and dynamic analysis.

3.4 Competitors and markets

An industry or sector may be too high a level to provide for a detailed understanding of
competition. The five forces can impact differently on different kinds of players, requiring a
more fine-grained understanding. For example, Hyundai and Porsche may be in the same
broad industry (automobiles), but they are positioned differently: they are protected by
different barriers to entry and competitive moves by one are unlikely to affect the other.
It is often useful to disaggregate. Many industries contain a range of companies, each of
which have different capabilities and compete on different bases. Some of these competitor
differences are captured by the concept of strategic groups. Customers too can differ signifi-
cantly, and these can be captured by distinguishing between different market segments.
Thinking in terms of different strategic groups and market segments provides opportunities
for organisations to develop highly distinctive positionings within broader industries. Besides
disaggregating the analysis of industry competition these approaches may help in under-
standing how value is created differently by different competitors. Competitor differences,
both actual and potential, including the identification of entirely new market spaces can also
be analysed using the strategy canvas and ‘Blue Ocean’ thinking, the last topic in this section.

3.4.1 Strategic groups

Strategic groups are organisations within the same industry or sector with similar stra-
tegic characteristics, following similar strategies or competing on similar bases.17 These
characteristics are different from those in other strategic groups in the same industry or
80
 3.4 Competitors and markets

Figure 3.5 Characteristics for identifying strategic groups

Strategic dimensions are based on the extent to which

organisations differ in terms of characteristics such as:

Scope of activities

• Extent of product (or service) range

• Extent of geographical coverage (e.g. national, regional, global)
• Number of market segments served
• Distribution channels used

Resource commitment

• Extent (number) of branding

• Marketing effort (e.g. advertising spread, size of salesforce)
• Extent of vertical integration
• Product or service quality
• R&D spending and technological leadership (leader vs. follower)
• Size of organisation

sector. For example, in the grocery retailing industry, supermarkets, convenience stores and
corner shops each form different strategic groups. There are many different characteristics
that distinguish between strategic groups and these can be grouped into two major catego-
ries of strategic dimensions (see Figure 3.5).18 First, the scope of an organisation’s activities
(such as product range, geographical coverage and range of distribution channels used).
Second, the resource commitment (such as brands, marketing spend and extent of vertical
integration). Which characteristics are relevant differs from industry to industry, but typically
important are those characteristics that separate high performers from low performers. It
helps to make a competitive force analysis first as it identifies different types of rivals.
Strategic groups can be mapped onto two-dimensional charts – for example, one axis
might be the extent of product range and the other axis the size of marketing spend.
One method for choosing key dimensions by which to map strategic groups is to identify
top performers (by growth or profitability) in an industry and to compare them with low
performers. Characteristics that are shared by top performers, but not by low performers, are
likely to be particularly relevant for mapping strategic groups. For example, the most profit-
able firms in an industry might all be narrow in terms of product range, and lavish in terms
of marketing spend, while the less profitable firms might be more widely spread in terms
of products and restrained in their marketing. Here the two dimensions for mapping would
be product range and marketing spend. A potential recommendation for the less profitable
firms would be to cut back their product range and boost their marketing.19
Figure 3.6 shows strategic groups among Indian pharmaceutical companies, with research
and development intensity (R&D spend as a percentage of sales) and overseas focus (exports
and patents registered overseas) defining the axes of the map. These two axes do explain
a good deal of the variation in profitability between groups. The most profitable group is
the Emergent globals (11.3 per cent average return on sales), those with high R&D intensity
and high overseas focus. On the other hand, the Exploiter group spends little on R&D and is
focused on domestic markets, and only enjoys 2.0 per cent average return on sales.
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Chapter 3 Industry and sector analysis

Figure 3.6 Strategic groups in the Indian pharmaceutical industry

High

Emergent
globals
(4)*
RoS: 11.3%
Explorers
(15)
R&D RoS: 10.8%
intensity

Outsourcers
(2)
Exploiters
RoS: 7.8%
(18)
RoS: 2.0%

Low
Low High
Overseas focus
* Brackets: Number of firms in group
RoS: Group average return on sales

Source: Developed from R. Chittoor and S. Ray, ‘Internationalisation paths of Indian pharmaceutical firms: a strategic
group analysis’, Journal of International Management, vol. 13 (2009), pp. 338–55.

This strategic group concept is useful in at least three ways:

• Understanding competition. Managers can focus on their direct competitors within their
particular strategic group, rather than the whole industry as rivalry often is strongest
between these. In general, strategic groups are influenced differently by the competitive
forces and this focus thus allows for a more specific industry structure analysis. They can
also establish the dimensions that distinguish them most from other groups, and which
might be the basis for relative success or failure. This suggests that there may be profit-
ability differences between different strategic groups and the differing dimensions can
then become the focus of their action.
• Analysis of strategic opportunities. Strategic group maps can identify the most attractive
‘strategic spaces’ within an industry. Some spaces on the map may be ‘white spaces’,
relatively under-occupied. In the Indian pharmaceutical industry, the white space is high
R&D investment combined with focus on domestic markets. Such white spaces might be
unexploited opportunities. On the other hand, they could turn out to be ‘black holes’,
impossible to exploit and likely to damage any entrant. A strategic group map is only the
first stage of the analysis. Strategic spaces need to be tested carefully.
• Analysis of mobility barriers. Of course, moving across the strategic group map to take
advantage of opportunities is not costless. Often it will require difficult decisions and rare
resources. Strategic groups are therefore characterised by ‘mobility barriers’, obstacles
to movement from one strategic group to another. These are the equivalent to barriers
to entry in five forces analysis, but between different strategic groups within the same
industry.

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 3.4 Competitors and markets

Although movement from the Exploiter group in Indian pharmaceuticals to the Emer-
gent global group might seem very attractive in terms of profits, it is likely to demand very
substantial financial investment and strong managerial skills. Mobility into the Emergent
global group will not be easy. As with barriers to entry, it is good to be in a successful strategic
group protected by strong mobility barriers, to impede imitation.

3.4.2 Market segments

The concept of strategic groups discussed above helps with understanding the similarities
and differences in terms of competitor characteristics. Industries can also be disaggregated
into smaller and specific market sections known as segments. The concept of market segment
focuses on differences in customer needs. A market segment20 is a group of customers who
have similar needs that are different from customer needs in other parts of the market.
Where these customer groups are relatively small, such market segments are often called
‘niches’. Dominance of a market segment or niche can be very valuable, for the same reasons
that dominance of an industry can be valuable following five forces reasoning.
Segmentation should reflect an organisation’s strategy21 and strategies based on market
segments must keep customer needs firmly in mind. Therefore, two issues are particularly
important in market segment analysis:

• Variation in customer needs. Focusing on customer needs that are highly distinctive
from those typical in the market is one means of building a long-term segment strategy.
Customer needs vary for a whole variety of reasons – some of which are identified in
Table 3.1. Theoretically, any of these factors could be used to identify distinct market
segments. However, the crucial bases of segmentation vary according to market. In
industrial markets, segmentation is often thought of in terms of industrial classifi-
cation of buyers: steel producers might segment by automobile industry, packaging
industry and construction industry, for example. On the other hand, segmentation by
buyer behaviour (e.g. direct buying versus those users who buy through third parties

Table 3.2 Some bases of market segmentation

Type of factor Consumer markets Industrial/organisational markets

Characteristics of people/ Age, gender, ethnicity Industry

organisations Income Location
Family size Size
Life-cycle stage Technology
Location Profitability
Lifestyle Management

Purchase/use situation Size of purchase Application

Brand loyalty Importance of purchase
Purpose of use Volume
Purchasing behaviour Frequency of purchase
Importance of purchase Purchasing procedure
Choice criteria Choice criteria
Distribution channel

Users’ needs and preferences for Product similarity Performance requirements

product characteristics Price preference Assistance from suppliers
Brand preferences Brand preferences
Desired features Desired features
Quality Quality
Service requirements

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Chapter 3 Industry and sector analysis

such as contractors) or purchase value (e.g. high-value bulk purchasers versus frequent
low-value purchasers) might be more appropriate. Being able to serve a highly distinc-
tive segment that other organisations find difficult to serve is often the basis for a secure
long-term strategy.
• Specialisation within a market segment can also be an important basis for a successful
segmentation strategy. This is sometimes called a ‘niche strategy’. Organisations that have
built up most experience in servicing a particular market segment should not only have
lower costs in so doing, but also have built relationships which may be difficult for others
to break down. Experience and relationships are likely to protect a dominant position
in a particular segment. However, precisely because customers value different things in
different segments, specialised producers may find it very difficult to compete on a broader
basis. For example, a small local brewery competing against the big brands on the basis of
its ability to satisfy distinctive local tastes is unlikely to find it easy to serve other segments
where tastes are different, scale requirements are larger and distribution channels are
more complex.

3.4.3 Critical success factors and ‘Blue Oceans’

Industry or sector analysis should also include an understanding of competitors and the
different ways they offer value to customers. As Michael Porter’s Five Forces Framework
underlines, reducing industry rivalry involves competitors finding differentiated positions in
the marketplace. W. Chan Kim and Renée Mauborgne at INSEAD propose two concepts that
help think creatively about the relative positioning of competitors in the environment and
finding uncontested market spaces: the strategy canvas and ‘Blue Oceans’.22
A strategy canvas compares competitors according to their performance on key success
factors in order to establish the extent of differentiation. It captures the current factors of
competition of the industry, but also offers ways of challenging these and creatively trying
to identify new competitive offerings. Figure 3.7 shows a strategy canvas for three electrical
components companies. The canvas highlights the following three features:

• Critical success factors (CSFs) are those factors that either are particularly valued by
customers (i.e. strategic customers) or provide a significant advantage in terms of cost.
Critical success factors are therefore likely to be an important source of competitive advan-
tage or disadvantage. Figure 3.7 identifies five established critical success factors in this
electrical components market (cost, after-sales service, delivery reliability, technical quality
and testing facilities). Note there is also a new sixth critical success factor, design advisory
services, which will be discussed under the third subhead, value innovation.
• Value curves are a graphic depiction of how customers perceive competitors’ relative
performance across the critical success factors. In Figure 3.7, companies A and B perform
well on cost, service, reliability and quality, but less well on testing. They do not offer any
design advice. They are poorly differentiated and occupy a space in the market where
profits may be hard to get because of excessive rivalry between the two. Company C, on
the other hand, has a radically different value curve, characteristic of a ‘value innovator’.
• Value innovation is the creation of new market space by excelling on established critical
success factors on which competitors are performing badly and/or by creating new critical
success factors representing previously unrecognised customer wants. Thus in Figure 3.7,
company C is a value innovator in both senses. First, it excels on the established customer
need of offering testing facilities for customers’ products using its components. Second,
it offers a new and valued design service advising customers on how to integrate their
components in order for them to create better products.

84
 3.5 Opportunities and threats

Figure 3.7 Strategy canvas for electrical component companies

High

Company A

Blue
Company B
Ocean

Perceived Company C
performance

Low
Cost After-sales Delivery Technical Testing Design
service reliability quality services advice
Critical success factors

Note: cost is used rather than price for consistency of value curves.
Source: Developed from W.C. Kim and R. Mauborgne, Blue Ocean Strategy, Harvard Business School Press, 2005.

A value innovator is a company that competes in ‘Blue Oceans’. Blue Oceans are new market
spaces where competition is minimised.23 Blue Oceans contrast with ‘Red Oceans’, where
industries are already well defined and rivalry is intense. Blue Oceans evoke wide empty seas.
Red Oceans are associated with bloody competition and ‘red ink’, in other words financial
losses. The Blue Ocean concept is thus useful for identifying potential spaces in the environ-
ment with little competition. These Blue Oceans are strategic gaps in the marketplace.
In Figure 3.7, company C’s strategy exemplifies two critical principles of Blue Ocean
thinking: focus and divergence. First, company C focuses its efforts on just two factors,
testing and design services, while maintaining only adequate performance on the other
critical success factors where its competitors are already high performers. Second, it has
created a value curve that significantly diverges from its competitors’ value curves, creating
a substantial strategic gap, or Blue Ocean, in the areas of testing and design services. This is
shrewd. For company C, beating companies A and B in the areas where they are performing
well anyway would require major investment and likely provide little advantage given that
customers are already highly satisfied. Challenging A and B on cost, after-sales service,
delivery or quality would be a Red Ocean strategy, increasing industry rivalry. Far better
is to concentrate on where a large gap can be created between competitors. Company C
faces little competition for those customers who really value testing and design services,
and consequently can charge good prices for them. The task for companies A and B now is
to find strategic gaps of their own.

3.5 Opportunities and threats

The concepts and frameworks discussed above and in Chapter 2 should be helpful in
understanding the factors in the macro-, industry and competitor/market environments
of an organisation. However, the critical issue is the implications that are drawn from this
understanding in guiding strategic decisions and choices. The crucial next stage, therefore,
is to draw from the environmental analysis specific strategic opportunities and threats for
the organisation. Identifying these opportunities and threats is extremely valuable when

85
Chapter 3 Industry and sector analysis

thinking about strategic choices for the future (the subject of Chapters 7 to 11). Opportun-
ities and threats form one half of the Strengths, Weaknesses, Opportunities and Threats
(SWOT) analyses that shape many companies’ strategy formulation (see Section 4.4.4). In
responding strategically to the environment, the goal is to reduce identified threats and take
advantage of the best opportunities.
The techniques and concepts in this and the previous chapter should help in identifying
environmental threats and opportunities, for instance:

• PESTEL analysis of the macro-environment might reveal threats and opportunities

presented by technological change, or shifts in market demographics or such like factors
(see Chapter 2).
• Identification of key drivers for change can help generate different scenarios for managerial
discussion, some more threatening and others more favourable.
• Porter’s five forces analysis might, for example, identify a rise or fall in barriers to entry, or
opportunities to reduce industry rivalry, perhaps by acquisition of competitors.
• Blue Ocean thinking might reveal where companies can create new market spaces; alter-
natively, it could help identify success factors which new entrants might attack in order
to turn ‘Blue Oceans’ into ‘Red Oceans’.

While all these techniques and concepts are important tools for understanding environments,
it is important to recognise that any analysis is likely to be somewhat subjective. Entrepren-
eurs and managers often have particular blinkers with regard to what they see and prioritise.
Techniques and concepts can be helpful in challenging existing assumptions and encour-
aging broader perspectives, but they are unlikely to overcome human subjectivity and biases
completely.

Thinking differently From five forces to one

A new view focuses on how value is created and captured.

A new ‘value network model’ based on cooperative that value as possible. Each player thus has a competition
game theory aspires to replace Porter’s competitive force and the strength of it depends on how many others
forces framework. 24 The power of his five competitive the player could create value with. For example, if a firm
forces defines the opportunities of a firm. The new model has many alternative suppliers and buyers to create value
rather emphasises how the firm’s opportunities depend with the strength of its competition force would go up as
on how a firm, suppliers and buyers create value together it can threaten to make transactions with someone else
in a network. They then compete for a share of that value and thus bargain up its share of the value pie this way. How
based on a single competition force that each player has. much value each player captures thus depends on the level
Compared to Porter’s framework the emphasis in this of interest in each player from others and how well a given
model is more on how value is created between parties. player persuades others in its network to part with value.
The firm and its suppliers and buyers comprise a value
network of transactions that create value to be shared
among them. All players in the network compete for Question
what player to make transactions and create value with: 1 How would you compare the ‘value network model’
suppliers compete for firms, and vice versa; firms compete including one single force with Porter’s five forces when
for buyers and vice versa. A firm, for example, wants to making an industry analysis? What is the benefit of foc-
make transactions with certain suppliers and customers to using on value creation compared to Porter’s approach?
create value, but also to make sure to capture as much of

86
 Work assignments

Summary
• The environment influence closest to an organisation includes the industry or sector
(middle layer in Figure 2.1).
• Industries and sectors can be analysed in terms of Porter’s five forces – barriers to entry,
substitutes, buyer power, supplier power and rivalry. Together with complementors these
determine industry or sector attractiveness and possible ways of managing strategy.
• Industries and sectors are dynamic, and their changes can be analysed in terms of the
industry life cycle and comparative five forces radar plots.
• Within industries strategic group analysis and market segment analysis can help identify
strategic gaps or opportunities (the inner layers in Figure 2.1).
• Blue Ocean strategies are a means of neutralising strong competitive forces and thus
avoiding Red Oceans with many similar rivals and low profitability and can be analysed
with a strategy canvas.

Work assignments
✱ Denotes more advanced work assignments.
* Refers to a case study in the Text and Cases edition.

3.1 Drawing on Section 3.2, carry out a five forces analysis of the pharmaceutical
industry* or SAB Miller’s position in the brewing industry (Megabrew*). What do you
conclude about that industry’s attractiveness?
3.2 Drawing on Section 3.2.3, identify an industry with network effects. Consider what
those might involve; why customers prefer certain services, products and companies
over others and why they may not easily switch to other services and companies.
3.3✱ Drawing on Section 3.3, and particularly using the radar plot technique of
Figure 3.4, choose two industries or sectors and compare their attractiveness in
terms of the five forces (a) today; (b) in approximately three to five years’ time.
Justify your assessment of each of the five forces’ strengths. Which industry or sector
would you invest in?
3.4 With regard to Section 3.4.1 and Figure 3.6, identify an industry (e.g. the car industry
or clothing retailers) and, by comparing competitors, map out the main strategic
groups in the industry according to key strategic dimensions. Try more than one set
of key strategic dimensions to map the industry. Do the resulting maps identify any
under-exploited opportunities in the industry?
3.5✱ Drawing on Section 3.4.3, and particularly on Figure 3.7, identify critical success
factors for an industry with which you and your peers are familiar (e.g. clothing
retailers or mobile phone companies). Using your own estimates (or those of your
peers), construct a strategy canvas comparing the main competitors, as in Figure 3.7.
What implications does your strategy canvas have for the strategies of these
competitors?

Integrative assignment
3.6✱ Carry out a full analysis of an industry or sector of your choice (using for example five
forces and strategic groups). Consider explicitly how the industry or sector is affected
by globalisation (see Chapter 9, particularly Figure 9.2 on drivers) and innovation
(see Chapter 10, particularly Figure 10.5 on product and process innovation).

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Chapter 3 Industry and sector analysis

Recommended key readings

• The classic book on the analysis of industries is M.E. • For an insightful discussion of complementors see D.
Porter, Competitive Strategy, Free Press, 1980. An Yoffie and M. Kwak, ‘With friends like these: the art of
update is available in M.E. Porter, ‘The five competitive managing complementors’, Harvard Business Review,
forces that shape strategy’, Harvard Business Review, vol. 84, no. 9 (2006), pp. 88–98.
vol. 86, no. 1 (2008), pp. 58–77. For an in-depth • An influential development on Porter’s basic ideas
discussion of how to apply Porter’s Competitive is W.C. Kim and R. Mauborgne, Blue Ocean Strategy:
Force Frameworks, see J. Magretta, Understanding How to Create Uncontested Market Space and Make
Michael Porter: The Essential Guide to Competition and Competition Irrelevant, Harvard Business School
Strategy, Harvard Business Review Press, 2012. Press, 2005.

References
1. See M.E. Porter, Competitive Strategy: Techniques for guide to the network economy. Harvard Business
Analyzing Industries and Competitors, Free Press, 1980, Press, 2013.
p. 5. 7. If network effects are present a standard strategic
2. See endnote 1 above and M. Porter, ‘The five compet- advice for companies has been to move in first and
itive forces that shape strategy’, Harvard Business grow fast to capture those effects before anyone else
Review, vol. 86, no. 1 (2008), pp. 58–77 and G. Yip, as this would provide an advantage over compet-
T.M. Devinney and G. Johnson, ‘Measuring long term itors, but it has recently been demonstrated that
superior performance: The UK’s long term superior there are other issues to consider: H. Halaburda and F.
performers 1984–2003’, Long Range Planning, vol. 42, Oberholzer-Gee, ‘The limits of scale’, Harvard Business
no. 3 (2009), pp. 390–413. See also www.damodaran. Review, April 2014, pp. 95–99.
com for industry profitability differences in various 8. The Five Forces Framework builds on the
geographical regions. structure-conduct-performance (SCP – Structure –
3. For a discussion and guide to Porter’s ideas about Conduct – Performance) model in industrial organ-
strategy see J. Magretta, Understanding Michael Porter isation economics. It stipulates that the industry
– The essential guide to competition and strategy, structure determines firm conduct that in turn influ-
Harvard Business Review Press, 2012. C. Christensen, ences industry performance. SCP categorises industry
‘The past and future of competitive advantage’, Sloan structure into four main types: monopoly, oligopoly,
Management Review, vol. 42, no. 2 (2001), pp. 105–09, monopolistic competition and perfect competition.
provides an interesting critique and update of some See J. Lipczynski, J. Wilson and J. Goddard, Industrial
of the factors underlying Porter’s five forces. A critical Organization – Competition, Strategy, Policy, 2009,
overview of Porter’s thinking is also provided in R. Prentice Hall/Financial Times.
Huggins and H. Izushi (eds), Competition, Competitive 9. D. McIntyre and M. Subramarian, ‘Strategy in network
Advantage, and Clusters: The Ideas of Michael Porter, industries: a review and research agenda’, Journal of
Oxford University Press, 2011. Management, vol. 35 (2009), pp. 1494–512.
4. A. Brandenburger and B. Nalebuff, ‘The right 10. Explicit cooperation among the firms to limit compe-
game’, Harvard Business Review, July–August 1995, tition or cartels are prohibited in most developed,
pp. 57–64. nations, but there is also ‘tacit collusion’. In tacit
5. See A. Brandenburger and B. Nalebuff, Co-opetition, collusion companies cooperate to reduce competi-
Doubleday, New York, 1996 and K. Walley, ‘Coopeti- tion without any formal agreement. It is facilitated by
tion: an introduction to the subject and an agenda a small number of rivals, a homogenous product or
for research’, International Studies of Management service and costs and high barriers to entry. Tacit collu-
and Organization, vol. 37, no. 2 (2007), pp. 11–31. On sion can also be illegal under certain circumstances.
the dangers of ‘complementors’, see D. Yoffie and See J. Lipczynski, J. Wilson and J. Goddard, Industrial
M. Kwak, ‘With friends like these’, Harvard Business Organization – Competition, Strategy, Policy, 2009,
Review, vol. 84, no. 9 (2006), pp. 88–98. Prentice Hall/Financial Times.
6. For an overview of recent empirical research of 11. Economists name these markets ‘monopolistic
strategy and network effects see D.P McIntyre and competition’ as firms can still create a position or
M. Subramaniam, ‘Strategy in network industries: niche for which they have some monopoly power
a review and research agenda’, Journal of Manage- over pricing.
ment (2009), pp. 1–24. For a general discussion of the 12. This definition is from R. D’Aveni, Hypercompetition:
role of networks externalities and standards see C. Managing the Dynamics of Strategic Maneuvering,
Shapiro and H.R. Varian, Information rules: a strategic Free Press, 1994, p. 2.

88
 References

13. There is a discussion of the static nature of the Porter 19. Strategic groups may also be associated with an
model, and other limitations, in M. Grundy, ‘Rethinking organisation’s own identity; see for example V. Anand,
and reinventing Michael Porter’s five forces model’, M. Joshi and A.M. O’Leary-Kelly, ‘An organizational
Strategic Change, vol. 15 (2006), pp. 213–29. identity approach to strategic groups’, Organization
14. See for example F. Hacklin, B. Battistini and G. Von Science, vol. 24, no. 2 (2013), pp. 571–90.
Krogh, ‘Strategic choices in converging industries’, MIT 20. A useful discussion of segmentation in relation
Sloan Management Review 55.1 (2013): 65–73. to competitive strategy is provided in M.E. Porter,
15. A classic academic overview of the industry life cycle Competitive Advantage, Free Press, 1985, Chapter 7.
is S. Klepper, ‘Industry life cycles’, Industrial and See also the discussion on market segmentation in
Corporate Change, vol. 6, no. 1 (1996), pp. 119–43. P. Kotler, G. Armstrong, J. Saunders and V. Wong, Prin-
16. A. McGahan, ‘How industries evolve’, Business Strategy ciples of Marketing, 5th European edn, Financial Times
Review, vol. 11, no. 3 (2000), pp. 1–16. Prentice Hall, 2008, Chapter 9.
17. For examples of strategic group analysis, see G. Leask 21. For a discussion of how market segmentation needs
and D. Parker, ‘Strategic groups, competitive groups to be broadly related to an organisation’s strategy and
and performance in the UK pharmaceutical industry’, not only narrowly focused on the needs of advertising
Strategic Management Journal, vol. 28, no. 7 (2007), see D. Yankelovich and D. Meer, ‘Redicsovering market
pp. 723–45; and W. Desarbo, R. Grewal and R. Wang, segmentation’, Harvard Business Review, February,
‘Dynamic strategic groups: deriving spatial evolutionary 2006, pp. 73–80.
paths’, Strategic Management Journal, vol. 30, no. 8 22. W.C. Kim and R. Mauborgne, Blue Ocean Strategy,
(2009), pp. 1420–39 and F. Mas-Ruiz, F. Ruiz Moreno Boston, Harvard Business School Press, 2005.
and A. Ladrón de Guevara Martínez, ‘Asymmetric 23. W.C. Kim and R. Mauborgne, ‘How strategy shapes
rivalry within and between strategic groups’, Strategic structure’, Harvard Business Review, September 2009,
Management Journal, vol. 35, no. 3 (2014), pp. 419–39. pp. 73–80.
18. These characteristics are based on Porter, endnote 1 24. M.D. Ryall, ‘The new dynamics of competition’, Harvard
above. Business Review, vol. 91, no. 60, 2013, pp. 80–87.

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Chapter 3 Industry and sector analysis

Case example
Game-changing forces and the global advertising industry
Peter Cardwell
This case is centred on the global advertising industry which through the concept of a brand being communicated
faces significant strategic game-changing forces driven by via media channels. Brands allow consumers to differen-
technological innovation, the rise of consumer spending tiate between products and services and it is the job of
in developing economies, changes in consumer media the advertising agency to position the brand so that it is
consumption and pressures from major advertisers for associated with functions and attributes which are valued
results-based compensation. by target consumers. These brands may be consumer
brands (e.g. Procter & Gamble, Samsung, Nestle) or
In the second decade of the new millennium, advertising business-to-business (B2B) brands (e.g. IBM, Airbus Indus-
agencies faced a number of unanticipated challenges. trie and UPS). Some brands target both consumers and
Traditional markets and industry operating methods, businesses (e.g. Microsoft and Apple).
developed largely in North America and Western Europe As well as private-sector brand companies, govern-
following the rise of consumer spending power in the ments spend heavily to advertise public-sector services
twentieth century, were being radically reappraised. such as healthcare and education or to influence indi-
vidual behaviour (such as ‘Don’t drink and drive’). For
example, the UK government had an advertising budget
of £300m (€335m) in the late-2010s. Charities, political
groups, religious groups and other not-for-profit organ-
isations also use the advertising industry to attract funds
into their organisation or to raise awareness of issues.
Together these account for approximately 3 per cent of
advertising spend.
Advertisements are usually placed in selected media
(TV, press, radio, mobile and desktop internet, etc.) by an
advertising agency acting on behalf of the client brand
company; thus they are acting as ‘agents’. The client
company employs the advertising agency to use its know-
ledge, skills, creativity and experience to create advert-
ising and marketing to drive consumption of the client’s
brands. Clients traditionally have been charged according
Source: PixieMe/Shutterstpck
to the time spent on creating the advertisements plus a
commission based on the media and services bought on
The industry was subject to game-changing forces behalf of clients. However, in recent years, larger advert-
from the so-called ‘digital revolution’ with the entry of isers such as Coca-Cola, Procter & Gamble and Unilever
search companies like Google, Facebook and Amazon as have been moving away from this compensation model
rivals for advertising budgets on mobile devices. Changing to a ‘value’ or results-based model based on a number of
patterns in global consumer markets impacted on both metrics, including growth in sales and market share.
industry dynamics and structure. Budgets being spent
through traditional advertising agencies were being Ad industry growth
squeezed as industry rivalry intensified with the entry of
specialist consultancies. Money spent on advertising has increased dramatic-
ally over the past two decades and in 2018 was over
$205billion (€176bn, £158bn) in the USA and $583 billion
Overview worldwide. While there might be a decline in recessionary
Traditionally, the business objective of advertising agen- years, it is predicted that spending on advertising will
cies is to target a specific audience on behalf of clients exceed $787 billion globally by 2022.
with a message that encourages them to try a product The industry is shifting its focus as emerging markets
or service and ultimately purchase it. This is done largely drive revenues from geographic sectors that would not

90
 Game-changing forces and the global advertising industry

Table 1 Global advertising expenditure by region (US$ million, at 2017 average rates)

2014 2015 2016 2017 2018

(estimate)

N America 169,277 175,024 183,075 191,130 196,099

W Europe 111,300 114,712 119,531 124,790 128,035

Asia Pacific 122,000 130,711 137,639 145,695 149,483

C & E Europe 32,284 35,514 36,691 37,305 38,275

Latin America 34,082 36,836 38,530 39,226 42,315

Africa/ME/ROW 25,941 28,044 29,334 28,608 29,352

World 494,884 520,841 544,800 566,754 583,599

Source: ZenithMedia, Statista, December 2018.

have been significant 5 to 10 years ago, such as the BRICS for nearly 50 per cent of the measured global advertising
countries and the Middle East and North Africa. This shift economy.
has seen the emergence of agencies specialising in Islamic Despite the increase in worldwide advertising revenues,
marketing, characterised by a strong ethical responsibility the holding companies that own the world’s largest adver-
to consumers. Future trends indicate the strong emer- tising groups: WPP, Publicis, Omnicom and Interpublic
gence of consumer brands in areas of the world where Group (see Table 2) are under intense pressure in a changing
sophisticated consumers with brand awareness are business environment to deliver shareholder value.
currently in the minority (see Table 1).
In terms of industry sectors, three of the top 10 global
Intensifying competition
advertisers are car manufacturers. However, the two major
fmcg (fast-moving consumer goods) producers Procter & Advertising agencies come in all sizes and include every-
Gamble and Nestlé are in the three top spots for global thing from one- or two-person ‘boutique’ operations
advertising spend. Healthcare and beauty (L’Oréal), (which rely mostly on freelance outsourced talent to
consumer electronics (Samsung), fast food, beverage and perform most functions), small- to medium-sized agen-
confectionery manufacturers are all featured in the top cies, large independents to multinational, multi-agency
20 global advertisers. The top 100 advertisers account conglomerates employing over 200,000 people. The

Table 2 Top five multi-agency conglomerates: 2017, by revenue, profit before interest and tax, number of
employees and agency brands

Group name Revenue PBIT Employees Advertising agency brands

1. WPP (UK) £15.2bn £2.16bn 200,000 GroupM, JWT, Grey, Ogilvy, Y&R

2. Omnicom (US) $15.4bn $2.059bn 76,000 BBDO, DDB, TBWA

3. Publicis Groupe €10.8bn €1.51bn 79,000 Leo Burnett, Saatchi & Saatchi, Publicis, BBH
(France)

4. IPG (US) $7.88bn $973m 49,700 McCann Erickson, FCB, MullenLowe Group

5. Dentsu (Japan) $7.2bn $938m 47,324 Aegis, Carat, Denstu Media, iProspect, Isobar

Sources: WPP, Omnicom, Publicis Groupe, IPG, Dentsu.

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Chapter 3 Industry and sector analysis

industry has gone through a period of increasing concen- differentiate themselves by offering a mix of web design/
tration through acquisitions, thereby creating multi- development, search engine marketing, internet advert-
agency conglomerates such as those listed in Table 2. ising/marketing, or e-business/e-commerce consulting.
While these conglomerates are headquartered in London, They are classified as ‘agencies’ because they create digital
New York, Paris and Tokyo, they operate globally. media campaigns and implement media purchases of ads
Large multi-agency conglomerates compete on the on behalf of clients on social networking and community
basis of the quality of their creative output (as indicated sites such as YouTube, Facebook, Instagram, Flickr and
by industry awards), the ability to buy media more cost- other digital media.
effectively, market knowledge, global reach and increas-
ingly range of digital services. Some agency groups The rise of mobile and the digital
have integrated vertically into higher-margin marketing
services. Omnicom, through its Diversified Agency
duopoly
Services, has acquired printing services and telemar- Search companies, such as Google, Bing and Yahoo and
keting/customer care companies. Other agency groups social network Facebook, exploit their ability to interact with
have vertically integrated to lesser or greater degrees. and gain information about millions of potential consumers
Mid-sized and smaller boutique advertising agen- of branded products. Facebook and Google have effectively
cies compete by delivering value-added services through become a ‘digital duopoly’ to the extent that they represent
in-depth knowledge of specific market sectors, special- almost 60 per cent of the global digital mobile ad market,
ised services such as digital and by building a reputation according to eMarketer, the research group.
for innovative and ground-breaking creative advertising/ Digital search and mobile advertising budgets are
marketing campaigns. However, they might be more reliant increasing faster than other traditional advertising media
on outsourced creative suppliers than larger agencies. as search companies like Google and Facebook generate
Many small specialist agencies are founded by former revenues from paid search as advertisers discover that
employees of large agencies. In turn, smaller specialist targeted ads on mobile and desktop are highly effective
agencies are often acquired by the large multi-agency (see Table 3). By 2017, Google had a 66 per cent market
conglomerates in order to acquire specific capabilities share of the $81.6bn spent on online search advertising
to target new sectors or markets or provide additional globally, with Facebook also increasing its share.
services to existing clients. Sir Martin Sorrell, the former CEO of WPP the world’s
With the development of the Internet and online largest multi-service agency group, pointed out that
search advertising, a new breed of interactive digital Google is a rival for the service relationships with WPP’s
media agencies established themselves. These agencies clients. WPP group spent more than $6bn of its clients’

Table 3 Global advertising expenditure by medium (US$ million, at 2016 average rates)

2013 2014 2015 2016 2017

Newspapers 93,019 92,300 91,908 90,070 88,268

Magazines 42,644 42,372 42,300 40,185 39,391

Television 191,198 202,380 213,878 210,670 210,459

Radio 32,580 33,815 35,054 34,457 34,130

Cinema 2,393 2,538 2,681 2,767 2,850

Outdoor 30,945 32,821 34,554 36,143 36,324

Internet – Mobile and 70,518 80,672 91,516 130,019 156,543

Desktop

Total 463,387 486,908 511,891 544,401 567,965

Note: The totals in Table 3 are lower than in Table 1, since that table includes advertising expenditure for a few countries where it is not
itemised by advertising medium.
Sources: ZenithMedia, e-Marketer, Statista, February 2018.

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 Game-changing forces and the global advertising industry

Table 4 US mobile ad spending 2015–2019

2015 2016 2017 2018 2019

(estimate) (estimate)

Mobile ad spending (US$bn) 28.72 40.50 49.81 57.78 65.87

% change 50.00% 41.00% 23.00% 16.00% 14.00%

% of digital ad spending 49.00% 60.40% 66.60% 67.70% 72.20%

% of total media ad spending 15.30% 20.40% 23.90% 26.30% 28.60%

Source: eMarketer.com

ad budgets with Google in 2017 and $2.1bn with Face- analytics and artificial intelligence are seen to be
book. Sorrell called Google a ‘frenemy’ – the combin- becoming more important than creativity which trad-
ation of ‘friend’ and ‘enemy’. Google is a ‘friend’ where itional advertising agencies have relied upon as a differ-
it allows WPP to place targeted advertising based on entiator. This is enabling them to offer a range of services
Google analytics and an ‘enemy’ where it does not share to the major marketing companies that compete directly
these analytics with the agency and becomes a potential with traditional advertising agencies.
competitor for the customer insight and advertising trad- The disruptive change in the advertising industry at
itionally created by WPP. the beginning of the twenty-first century started with the
Mobile ad spending on sites such as YouTube, Internet. The convergence of Internet, TV, smartphones,
Pinterest and Twitter continues to increase at the tablets and laptop computers has had a major impact on
expense of desktop, taking a bigger share of marketers’ the advertising industry.
budgets. The shift to mobile ad spending is being driven Factors that have driven competitive advantage to date
mainly by consumer demand and is predicted to be over may not be relevant in the future. Traditionally the advert-
28 per cent of total media ad spending in the US which ising industry has embodied the idea of creativity as the
is why Google has made acquisitions in this sector (see vital differentiator between the best and the mediocre –
Table 4). and individuals have often been at the heart of this
creativity. The emergence of data analytics, programmatic
Entry of ‘big data’ technology advertising and the use of artificial intelligence algorithms
are disruptive to ‘business as usual’ in the industry. A key
consultancies
question is whether creativity will be important in the
The analysis of ‘big data’ is playing an increasingly future, in relation to breadth of services, global reach and
important role in helping to create targeted and person- data analysis.
alised advertising campaigns for the world’s major Sources: ZenithMedia, Advertising Age, Statista, eMarketer, February
marketers. Consultancies, such as Accenture Interactive 2018.
and IBMiX, as well as the large accountancy firms PwC
Digital Services and Deloitte Digital, all with global reach,
are now competing for a share of the advertising market Questions
by acquiring creative agencies to add to their ‘big data’
1 Carry out a five forces analysis of the advertising
digital services and have now entered the top 10 agencies
industry. What are the strengths of the five forces
ranked on the basis of turnover.
and what underlying factors drive them? What is the
Their services include programmatic advertising and
industry attractiveness?
the use of artificial intelligence algorithms that analyse
consumer behaviour allowing for real-time campaign 2 What strategic group dimensions and strategic
optimisations towards an audience more likely to groups can you identify? What are the differences
convert to the advertiser’s product or service, which is between them?
a major innovation, the impact of which is still being 3 Which PESTEL factors are driving changes in the
assessed. industry? Which factors are becoming more negative
This has led some industry experts to observe that or positive for the major advertising agencies?
‘Madmen’ now need to become ‘Mathsmen’, as data

93