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The Business Use Of Pestel Analysis Commerce Essay

According to Ryanair (2010) Ryanair is the world's favourite airline with 41 bases and 1100+ low fare routes across 26 countries, connecting 153 destinations. Ryanair currently has a team of more than 7,000 people and expects to carry approximately 73 million passengers in fiscal year 2010/11. What sort of environment are Ryanair currently competing in? According to the University of Oxford (2007) there are many factors in the macro-environment that will effect the decisions of the managers of any organisation. Tax changes, new laws, trade barriers, demographic change and government policy changes are all examples of macro change. To help analyse these factors managers can categorise them using the PESTEL model. Mintzberg (1994) explains that an “organisation needs a sense of where it is going and what forces in its environment are going to help or hinder it in achieving its goal”. Porter (1985) suggests that it “helps the organisation to explore a limited number or possible directions and create a model of how their actions are going to affect that environment”. Hollins & Shinkins (2006) say the PESTEL model is a fundamental feature of strategy development. Ryanair’s strategic analysis can be shown through using the PESTEL model.

Please refer to Appendix A for what a PESTEL model is.

It is very important that an organization considers its environment before beginning the marketing process. In fact, environmental analysis should be continuous and feed all aspects of planning.

Political

Charalambous (2009) goes on to talk about for the past several year’s, the Cyprus Tourism Organisation (CTO) has been attempting to woo low-cost carriers such as Ryanair. However the Irish airline, which recently touted charging passengers to use aircraft toilets, had been pushing for the government to lower airport fees. As the European Union prohibit direct subsidies by governments to their airlines, Kallas (2010) says the European Union Commission works to establish a level-playing field among the region’s airlines. Almunia (2010) states the application of an EU-wide competition policy helps create a level-playing field for business across Europe. It creates opportunities for companies, which have access to a wider market for their goods and services. It also creates challenges that improve their performance, as they find themselves competing with companies from across the EU. Various countries were keen to have a level-playing field across the European Union, not only in the airline division but also in other key and relevant areas in their countries.

Economics

Walters (2009) states the slump in Aer Lingus's share price is to an all-time low comes after the Irish airline presented a much gloomier outlook than the one it offered when fighting off Ryanair's €748 million takeover offer last December. Bliss & Braham (2008) explain “despite a downturn in the global economy, and the potential short-term effects this may have on the industry, the long-term prospects for the aviation sector are healthy”. Blake (2010) clarifies the latest official data shows the UK economy grew at a faster rate than first thought at the end of 2009.

The following also falling into this category:

The threat of Oil Prices

Taxes and Interest rates

Depreciation of US dollars

Increasing business class travelling

The threat of the substitutes

Rise of airport handling charges

Social

According to Baum (2004) issues of social inclusiveness are important considerations in the context of the tourism and leisure industries. Calder (2002) goes on to talk about how air travel has served to lower prices for all consumers also creating popular awareness of modes of low cost travel. Ryanair have developed a wider demographic of consumers got attracted to the low cost strategy. However recently the Times (2010) talks about how the volcanic ash cloud didn’t affect low cost carriers such as Ryanair (5million per day) as much as airlines such as British Airways (20 million per day), the passengers could also be put off by the recent travel chaos and decide to stay home this summer.

The following also falling into this category:

After 9/11 people have started to hesitate to flying.

In recession times people do not want to fly abroad for holiday vacations

Increase in grey market. Grey market is the trade of a commodity through distribution channels, which while legal, are unofficial, unauthorized, or unintended by the original manufacturer.

Populations growth - does an ageing population affect them i.e. baby boomers, lots of people in that life stage have more disposable income to spend

Safety solutions

Trends

Technological

Ryanair offers online reservation through internet facility that provided customers with more comfort and ease. The BBC (2009) reports Ryanair has become the first carrier to offer in-flight mobile services on regular routes across UK airspace. Smith (2009) states Ryanair has installed the new service on 20 of its aircraft but it plans to extend it to the whole of its fleet within the next 18 months. Bates (2009) found the users of the mobile service surprisingly good although hesitant to use at first, for most people finance is a secondary factor when dealing with an emergency call.

The following also falling into this category:

Internet sales / Increased internet competitions

High speed trains

Online check-in

Low fuel consumption

Environment

Ryanair (2010) state they are currently the industry leader in terms of environmental efficiency and it is constantly working towards further improving its performance. However Ryanair makes large number of flights everyday as their business model calls for having their planes in the air for most of the time. According to Vidal (2007) cheap flights, globalisation and the mounting cost of train travel have made aviation by far the fastest growing source of carbon dioxide in the UK. Ryanair will always be targeted by environmental enthusiasts due to the cheapness and the amount of airtime their planes are getting. The carbon footprint on the environment can only be lowered if the airlines minimise the number of flights.

The following also falling into this category:

Noise level controls

Global warming

Green house gas effect (Carbon emission level)

CSR (Corporate Social Responsibilities) Policy

Legal

CNN (2008) report the budget airline Ryanair faces an investigation from the UK's consumer and competition authority following allegations of misleading and unfair advertising. The Telegraph (2002) reported a complaint was received by the Advertising Standards Authority (ASA) from a member of the public who tried to book a ticket and found the offer applied only to midweek flights. However Smith (2009) states Ryanair has promised to give greater prominence to information regarding “optional” charges, such as those for checking in luggage, and will provide clearer information on its promotions and low price guarantee. There are many legal battles that Ryanair have had to face, which have been heavily publicised, therefore bad media coverage draws the consumers away.

The following also falling into this category:

Privatizing of airline industry

Illegal subsidies from airports

Competition laws in aviation industry

Allegations of misleading advertisement

Regulations about Carbon emission level

Ryanair need to determine what their strategy should be, they must reflect on the internal strengths and weaknesses while comparing these with the external opportunities. This process is known as SWOT analysis. Hollins & Shinkins (2006) say another fundamental strategy development analysis like the PESTEL model is the SWOT analysis.

Please refer to Appendix B for a SWOT analysis.

SWOT ANALYSIS

A SWOT analysis is a tool for auditing an organisation and its environment. To help focus on key issues companies would use the SWOT analysis in the first stage of planning. SWOT stands for strengths, weaknesses, opportunities, and threats. Strengths and weaknesses are internal factors. Opportunities and threats are external factors.

Strengths

Ryanair’s main focus is given on pursuing the low cost strategy, which supports its mission ‘to make flying possible for everyone’, the low airport charges which enables to reduce costs. Since the establishment and the help of deregulation they have grown from strength to strength building their brand name Ryanair which has become very well recognised in the airline industry. Michael O'Leary is Chief Executive Officer of the Irish airline Ryanair who leads a strong and aggressive pricing strategy. Cutting costs wherever they can allows them to lower their prices. 100% of their bookings are made through the internet therefore no sales commissions as there are no free complimentary meals also everything has a price. Ryanair is always in the public eye due to being a very successful low cost carrier, also O’Leary’s controversial side. Ryanair uses regional airports thus having the first mover advantage. O’Leary cleverly put together his marketing and strategic team who are constantly finding new and better tactics to be the best, as mentioned earlier Ryanair was the first to allow in flight mobile service.

Weakness

Ryanair are always in the media for the wrong reasons and this can hurt their reputation, and people tend to avoid companies with bad press. Smith (2009) states Ryanair charges more for in-flight food and drink than any of the other principal British or Irish airlines, according to new research. The poor service Ryanair provides leads to customer dissatisfaction not long ago Channel 4 aired Dispatches (2006) which was based on Ryanair staff caught napping, the documentary criticised Ryanair's training policies, security procedures and aircraft hygiene, and highlighted poor staff morale.

Opportunities

Osborne (2009) goes on to talk about how the long recession would enhance Ryanair’s competitive position. The longer and deeper this recession, the better it will be for the lowest cost producers in every sector, example Lidl, Aldi and Ikea. Milmo (2008) says the Dublin-based carrier was adamant that passenger growth would remain strong. It’s simple due to the recession people don’t want to pay high prices anymore and Ryanair will emerge from the current downturn in the industry within an even stronger position.

Threats

Milmo (2008) talks about how the rising of fuel costs, deteriorating consumer confidence and the weak pound would put severe pressure on costs, for Ryanair profits for the next financial year could fall by up to 50% to €235m (£176.2m) as a result, depending on oil prices and consumer demand. As the recession continues it has a major impact on the reduced travel of airline passengers, the competition between low cost airlines grows with Easy jet also being a major player.

PORTERS 5 FORCES ANALYSIS

According to the University of Oxford (2007) the competitive structure of an industry can be analysed using Porter's five forces. This model attempts to analyse the attractiveness of an industry by considering five forces within a market. According to Porter (1980) the likelihood of firms making profits in a given industry depends on five factors:

New Entrants

Bargaining Power of Customers

Bargaining Power of Suppliers

Competitive Rivalry

Threat of Substitutes

New Entrants

New entrants find it very difficult in the airline industry as there remains significant entry barriers in the sector. Vecchio (2000) explains the threat of new entrants presents the possibility that new firms will enter the industry and diminish industry returns by passing along value to buyers in the form of lower prices and raising the cost of competition. For new entries barriers would be the large capital and investments costs, advertising, buying or renting a Boeing, staff and training, economies of scale, switching costs, and brand value.

Bargaining Power of Customers

There is no customer loyalty with Ryanair also the customers are highly price sensitive especially being in a recession. Ranson (2007) reports Ryanair has consistently slammed travel agents, claiming it does not need agents to operate and they are the pariahs of the travel industry.

Therefore Ryanair only uses internet bookings or direct bookings thus decreasing the power of travel agents. Vecchio (2000) talks about buyers are presented many choices when choosing an airline carrier, because of the Internet, pricing information is less fragmented and easier to compare. Customers usually find price discrepancies for the same exact flight.

Bargaining Power of Suppliers

There are two major aircraft suppliers who are Boeing and Airbus, Ryanair’s supplier is Boeing. Matlack (2009) reports theses two suppliers have been battling it out for the past 40 years. For Ryanair changing suppliers would be too costly as they would have to change all data relating to their aircraft.Vecchio (2000) suggests supplier concentration makes it difficult for competitors to exercise leverage over the supplier and obtain lower prices or play one supplier against another. Therefore the supplier power further diminishes the ability of competitors to earn high profits.

Ryanair is depends on fuel prices as it is a low cost carrier. Milmo (2008) states O'Leary's warning that fuel costs could damage profits had some credence. Ryanair has no protection against a steep oil price this year, because the airline has not hedged its fuel requirements - a process whereby a company buys fuel in advance at a fixed price.

Primary airports have greater bargaining power due to the air traffic, and secondary airports are used by low cost carriers such as Ryanair. As low cost carriers increase so does the competition therefore the bargaining power of secondary airports increases. More traffic more bargaining power.

Competitive Rivalry

The airline industry is highly competitive, and Ryanair’s biggest rival is Easy jet. Hawkes (2007) states Easy jet and Ryanair launch price war, Dowling (2010) talks about how the two battle it by mocking each other through various advertisements. Vecchio (2000) suggests the factors that affect competitive rivalry include industry growth, fixed costs, brand identity, and barriers to exit.

Threat of Substitutes

With Ryanair their customers are not hesitant to find an alternative due to the cheapness and there are no switching costs for customers. There is no close relation with the customers so there is no brand loyalty. Corrigan (2010) goes on to talk about how there are alternatives to Ryanair and flying with Ryanair isn’t always the cheapest.

PORTERS GENERIC STRATEGY

A firm positions itself by leveraging its strengths. Porter (1998) has argued that a firm's strengths ultimately fall into one of two headings: cost advantage and differentiation. By applying these strengths in either a broad or narrow scope, three generic strategies result:

Cost Leadership

Differentiation

Focus

Ryanair is operating in the low cost airline segment of the market and its main focus is given on pursuing the cost reduction strategy. What position would Ryanair be in the market place? Using Porter’s generic strategies you can define Ryanair’s position. It is evident that Ryanair utilizes all three of these strategies. The cost leadership strategy calls for being the low cost producer in an industry for a given level of quality. They offer cheaper fares than their competitors do. Ryanair focused of people who couldn’t afford to fly full fare airlines, with their cheap offers flying was made easy to any traveller. Porter (1998) clarifies a differentiation strategy calls for the development of a product or service that offers unique attributes that are valued by customers and that customers perceive to be better than or different from the products of the competition. Puget (2003) states in a competitive environment, even cost leaders need to differentiate, as mentioned earlier Ryanair have become the first European airline to allow in flight mobile phone service. Ryanair’s main purpose revolves around the no frills service with low fares, which is designed to fire up demand. According to Ryanair (2010) in 1990 Ryanair accumulates £20m in losses and goes through a substantial restructuring. The Ryan family invest a further £20m. in the company, and copying the Southwest Airlines low fares model the airline is re-launched under new management as Europe's first low fares airline. To obtain a cost leader strategy Ryanair had to shift strategies, the mass of passengers have been growing due to the low costs. Being uncertain where Ryanair’s generic strategy to be placed one could say it appears between focuser and cost leader but mainly towards focuser. As O’Leary became in charge he quickly decided to maintain and follow the cost leader strategy as he saw this was the most profitable.

BOWMAN’S STRATEGY CLOCK

Please refer to Appendix D for Bowman’s Strategy Clock.

The 'Strategy Clock' is based upon the work of Cliff Bowman. With Bowman’s strategy clock you can analyse a company’s competitive position in comparison to the offerings of competitors.

Bowman (1996) considers competitive advantage in relation to cost advantage or differentiation advantage, the same as Porter’s Generic Strategies mentioned previously. The strategy clock revolves around 8 options. Using this we can examine Ryanair’s business environment.

Low added value

Low price

Hybrid

Differentiation

Focused differentiation

Increased price/standard

Increased price/low value

Low value/standard price

By using Bowman’s strategy clock you can analyze Ryanair’s competitive advantage. Ryanair left its competitors stunned through the dramatic changes they went through in the past decade. Ryanair realized what the customers wanted, transportation that was fast and inexpensive. In order to provide such a cheap method of transportation, low costs and efficiency were essential. Competitors were left amazed with increment of profitability that was made in a short period of time. The new strategy that was implemented became really effective the low fares without frills and by using secondary airports their punctuality in flight service improved their profitability period and brought major value on the growth of Ryanair. Massey & West (2007) states Ryanair plans to go from a low- cost airline to a "no- cost airline" - making tickets free but earning more from add-ons such as food and luggage charges.

The high level of competition within the airline industry can be ruthless and Ryanair needs efficient strategy to gain advantages and at the same time generate high profit, as mentioned earlier they become the first European airline to allow in flight calls. From viewing Bowman’s clock Ryanair can be placed between the various options of 1 to 5 in order to sustain their status of productivity and profitability. Since O’Leary focused on the low cost strategy, in recent days Ryanair can be placed between the options of 1 and 2 which are all about low price. For Ryanair to be positioned in option 3 the can be the strongest airline in the competition that is if they secure their price and give higher valued service.

STRATEGIC CAPABILITIES

By identifying the tangible and intangible within Ryanair their resources and capabilities can be found. A key strategic capability for Ryanair is their ability to manage their low-cost business model. Ratnasari (2009) talks about how the market and environment establish external constraints and pressures, a firm’s response through resource allocation and capability development become a source of competitive advantage.

Resources are tangible and intangible assets Ryanair uses to choose and implement its strategies.

The resources of Ryanair are:

Physical Resources – consists of the resources that are needed to operate such as aircraft fleet, headquarter, secondary airports.

Human Resources – the company has more than 7000 employees.

Financial Resources – The financial resources of the company comes from the Ryan Family, shareholders, investors and creditors.

Intellectual Capital – these are the knowledge, skills, abilities and talents that every in Ryanair possesses.

Capabilities are the skills a firm uses to bring its resources to bear. The capabilities of the firm are:

Lowest airfare rates

Simple processes (no frills)

Large brand awareness

Clear offer (focuses on particular market segment)

Innovative strategies on cost cutting

Quick turnaround time

It is clear that Ryanair has an advantage over other airlines who are adjusting to a lower cost model only to match the requirements of the airline sector, related to what actually customers are willing to pay for. For this low cost strategy to work effectively Ryanair has assembled a team more than 7000 employees who can deliver the services of customer needs. With fuel cost and personnel cost being really high in the airline industry it would limit other company’s to copy the low cost model that Ryanair has developed.

With the value chain of Ryanair Hollins & Shinkins (2006) goes on to talk about how costs are taken out of the value chain by minimizing the amount of time their planes actually spend on the ground. Faster turnarounds can be achieved by speeding up the cleaning process, hence no peanuts or meals. Drinks and snacks are of course available for purchase, not distributed for free as the full cost airlines do. The main objective of Ryanair is to offer low cost flights to customers which will increase the numbers of travelers. Also with the value chain as mention earlier employees who provide the customer needs and service, the airports that Ryanair operates in, as of the suppliers of the Boeings and their parts and other equipment.

The government airports work closely with Ryanair in ensuring an agreement that benefits both Ryanair and also the local city or community where Ryanair lands their planes in. Smith (2010) reports Ryanair of receiving subsidy’s, from local authorities from Canary Islands. Ryanair’s suppliers of the Boeing help customise their fleet to provide their basic low cost service model for travellers.Due to fleet commonality the firm is able to cut on costs in obtaining spares and maintenance services. In order to reduce airport charges, the firm avoids congested main airports and chooses secondary and regional airport destinations which are very interested in increasing passenger throughput. In order to control employee compensation costs, the firm implements a performance related pay structure. Although the company provides lower labor costs, the employees can earn additional pay or remuneration base on their performance. Due to Ryanair dealing with online booking or direct booking this reduces travel agents commission, through this there marketing costs are reduced, the firm’s main advertisement tools are newspapers, radio, television and its company website.

ANSOFF GROWTH MATRIX

The Ansoff Growth matrix is a tool that helps companies to decide their product and market growth strategy. Ansoff’s product/market growth matrix suggests that a business’ attempts to grow depend on whether it markets new or existing products in new or existing markets.

From viewing Ryanair’s track record they have successfully created a market attraction through offering their services of flight in a most affordable and reasoning price. With the low fares scheme Ryanair has become one of the top major players in the European airline industry.

As mentioned earlier Ryanair are flying to the Canary Islands with over 30 flights slowly Ryanair are moving into the international market. Ryanair are always looking to further and develop their airline moving to existing and new markets. Ryanair with its operations in various locations and destinations have diversified people and management in which they operate and the success of making them unite and one is great factor to further penetrate and develop their products to existing and new markets.

Conclusion

Ryanair is excellent at doing what it does best, selling low cost fares undercutting competitors while incrementing vast profits within the airline industry. The airline sector has been hugely affected by the economic meltdown caused by the recession although Ryanair has shown stronger resiliency relative to its competitors. The high cost carriers such as British Airways lost out 20% of profits whereas Ryanair only lost less than 10% of its profits during the volcano crisis.

In the future, Ryanair on its current trajectory can continuously obtain its position well in the airline industry, this can be done by pursuing innovative ideas such as the in flight mobile service and opportunities that distinguishes itself from other competitors. Also the weaknesses need to be identified and addressed. By rectifying its weaknesses, Ryanair will be able to continue to attract the demand of customers.

Appendix A

PESTEL analysis of the macro-environment

Political factors. These refer to government policy such as the degree of intervention in the economy. What goods and services does a government want to provide? To what extent does it believe in subsidising firms? What are its priorities in terms of business support? Political decisions can impact on many vital areas for business such as the education of the workforce, the health of the nation and the quality of the infrastructure of the economy such as the road and rail system.

Economic factors. These include interest rates, taxation changes, economic growth, inflation and exchange rates. As you will see throughout the "Foundations of Economics" book economic change can have a major impact on a firm's behaviour. For example:

               - higher interest rates may deter investment because it costs more to borrow

               - a strong currency may make exporting more difficult because it may raise the price in terms of foreign currency

               - inflation may provoke higher wage demands from employees and raise costs

               - higher national income growth may boost demand for a firm's products

Social factors. Changes in social trends can impact on the demand for a firm's products and the availability and willingness of individuals to work. In the UK, for example, the population has been ageing. This has increased the costs for firms who are committed to pension payments for their employees because their staff are living longer. It also means some firms such as Asda have started to recruit older employees to tap into this growing labour pool. The ageing population also has impact on demand: for example, demand for sheltered accommodation and medicines has increased whereas demand for toys is falling.

Technological factors: new technologies create new products and new processes. MP3 players, computer games, online gambling and high definition TVs are all new markets created by technological advances. Online shopping, bar coding and computer aided design are all improvements to the way we do business as a result of better technology. Technology can reduce costs, improve quality and lead to innovation. These developments can benefit consumers as well as the organisations providing the products.

Environmental factors: environmental factors include the weather and climate change. Changes in temperature can impact on many industries including farming, tourism and insurance. With major climate changes occurring due to global warming and with greater environmental awareness this external factor is becoming a significant issue for firms to consider. The growing desire to protect the environment is having an impact on many industries such as the travel and transportation industries (for example, more taxes being placed on air travel and the success of hybrid cars) and the general move towards more environmentally friendly products and processes is affecting demand patterns and creating business opportunities.

Legal factors: these are related to the legal environment in which firms operate. In recent years in the UK there have been many significant legal changes that have affected firms' behaviour. The introduction of age discrimination and disability discrimination legislation, an increase in the minimum wage and greater requirements for firms to recycle are examples of relatively recent laws that affect an organisation's actions. Legal changes can affect a firm's costs (e.g. if new systems and procedures have to be developed) and demand (e.g. if the law affects the likelihood of customers buying the good or using the service).

Different categories of law include:

consumer laws; these are designed to protect customers against unfair practices such as misleading descriptions of the product

competition laws; these are aimed at protecting small firms against bullying by larger firms and ensuring customers are not exploited by firms with monopoly power

employment laws; these cover areas such as redundancy, dismissal, working hours and minimum wages. They aim to protect employees against the abuse of power by managers

health and safety legislation; these laws are aimed at ensuring the workplace is as safe as is reasonably practical. They cover issues such as training, reporting accidents and the appropriate provision of safety equipment

Typical PESTEL factors to consider include:

Factor

Could include:

Political

e.g. EU enlargement, the euro, international trade, taxation policy

Economic

e.g. interest rates, exchange rates, national income, inflation, unemployment, Stock Market

Social

e.g. ageing population, attitudes to work, income distribution

Technological

e.g. innovation, new product development, rate of technological obsolescence

Environmental

e.g. global warming, environmental issues

Legal

e.g. competition law, health and safety, employment law

Appendix B

Developing a strategy: SWOT analysis

Strengths are internal factors that a firm may build on to develop a strategy. For example, they may include:

Marketing strengths e.g. a strong brand or access to a good distribution network

Financial strengths e.g. a high level of cash, access to loan capital if needed and a good credit rating

Operations strengths e.g. a high level of efficiency, flexible production systems and high quality levels

HRM strengths e.g. a well trained workforce, a creative and motivated workforce and good employer-ee relations

Weaknesses are internal factors that a firm may need to protect itself against such as:

Marketing weaknesses such as limited distribution, a poor product range and ineffective promotion

Financial weaknesses such as high levels of borrowing and low rates of return

Operational weaknesses such as old, inefficient equipment and poor quality

HRM weaknesses such as a high rate of labour turnover and industrial disputes

Managers must identify the specific strengths and weaknesses of their business and rate these according to how significant they are. They should then compare these with the external opportunities and threats identified by PESTEL analysis. This is SWOT analysis.SWOT table

A strategy may be developed by using a firm's strengths to exploit the opportunities that exist. For example, a strong brand name may be used to extend a firm's products into new markets. It may also use these strengths to protect itself against threats; for example, a retailer may use its finance to acquire key locations to prevent a competitor buying them.

A firm may also want to protect itself against its weaknesses. For example, it may try to find alternative suppliers to reduce an over-reliance on a particular one; it may invest in a rebranding exercise to reposition itself.

Undertaking a SWOT analysis effectively is not as easy as it may seem. First managers have to correctly identify what all the relevant factors are and how important each one is. Too often managers have their own perspective on a situation and therefore may only see what they want to see (as with PESTEL analysis). This is known as "perceptual filtering". Kodak's managers spent several years watching other camera manufacturers when they should have been watching consumer electronics firms such as Sony who were developing digital cameras.

Secondly, managers need to work out the most appropriate strategy that combines the strengths and opportunities and actually implement the plan successfully. Putting a plan into action can be more difficult than coming up with it in the first place due to resistance from staff or unexpected problems getting things done.

It is also important to undertake this type of analysis regularly because the competitive landscape and the internal situation will be constantly changing.

The importance of strategy should not be underestimated. Changing the price of an item, changing the distribution strategy and investing in new equipment are all important decisions but if you are fighting in the wrong market with the wrong products then the details are almost irrelevant. The strategy sets out where and how the battles will be fought and a good strategy is essential to business success. This involves an understanding not only of what happens within the firm but also the ability to forecast changes in the external environment and their significance successfully.

As the internal and external environments change so must a firm's strategy to maintain an appropriate fit. In "Foundations of Economics" you will read about all kinds of economic factors that can change; these will alter a firm's playing field and the rules of the game. This in turn means that managers need to consider carefully what team they pick and how they decide to play the match. i.e as the economy changes the strategy may need to change as well.

Appendix C

The likelihood of new entry i.e. the extent to which barriers to entry exist. The more difficult it is for other firms to enter a market the more likely it is that existing firms can make relatively high profits.

The likelihood of entering a market would be lower if:

the entry costs are high e.g. if heavy investment is required in marketing or equipment

there are major advantages to firms that have been operating in the industry already in terms of their experience and understanding of how the market works (this is known as the "learning effect")

government policy prevents entry or makes it more difficult; for example, protectionist measures may mean a tax is placed on foreign products or there is a limit to the number of overseas goods that can be sold. This would make it difficult for a foreign firm to enter a market

the existing brands have a high level of loyalty

the existing firms may react aggressively to any new entrant e.g. with a price war

the existing firms have control of the supplies .e.g. entering the diamond industry might be difficult because the majority of known sources of diamonds are controlled by companies such as De Beers.

2. The power of buyers.

The stronger the power of buyers in an industry the more likely it is that they will be able to force down prices and reduce the profits of firms that provide the product.

Buyer power will be higher if:

there are a few, big buyers so each one is very important to the firm

the buyers can easily switch to other providers so the provider needs to provide a high quality service at a good price

the buyers are in position to take over the firm. If they have the resources to buy the provider this threat can lead to a better service because they have real negotiating power

3. The power of suppliers.

The stronger the power of suppliers in an industry the more difficult it is for firms within that sector to make a profit because suppliers can determine the terms and conditions on which business is conducted.

Suppliers will be more powerful if:

there are relatively few of them (so the buyer has few alternatives)

switching to another supplier is difficult and/or expensive

the supplier can threaten to buy the existing firms so is in a strong negotiating position

4. The degree of rivalry

This measures the degree of competition between existing firms. The higher the degree of rivalry the more difficult it is for existing firms to generate high profits.

Rivalry will be higher if:

there are a large number of similar sized firms (rather than a few dominant firms) all competing with each other for customers

the costs of leaving the industry are high e.g. because of high levels of investment. This means that existing firms will fight hard to survive because they cannot easily transfer their resources elsewhere

the level of capacity utilisation. If there are high levels of capacity being underutilised the existing firms will be very competitive to try and win sales to boost their own demand

the market is shrinking so firms are fighting for their share of falling sales

there is little brand loyalty so customer are likely to switch easily between products

5. The substitute threat.

This measures the ease with which buyers can switch to another product that does the same thing e.g. aluminium cans rather than glass or plastic bottles. The ease of switching depends on what costs would be involved (e.g. transferring all your data to a new database system and retraining staff could be expensive) and how similar customers perceive the alternatives to be.

Using Porter's analysis firms are likely to generate higher returns if the industry:

Is difficult to enter

There is limited rivalry

Buyers are relatively weak

Suppliers are relatively weak

There are few substitutes.

On the other hands returns are likely to be low if:

The industry is easy to enter

There is a high degree of rivalry between firms within the industry

Buyers are strong

Suppliers are strong

It is easy to switch to alternatives

The implication of Porter's analysis for managers is that they should examine these five factors before choosing an industry to move into. They should also consider ways of changing the five factors to make them more favourable.

For example:

if firms merge together this can reduce the degree of rivalry . This has happened a great deal in industries such as automobiles, pharmaceuticals and banking where firms have joined together to remove competitors

if firms buy up distributors (this is called forward vertical integration) they can gain more control over buyers

if firms differentiate their product perhaps by trying to generate some form of Unique Selling Proposition (USP) that makes it stand out from the competition. This lies at the heart of many marketing and brand building activities. Coca Cola, for example, has fought hard to promote itself as "the real thing"; everything else is just imitation!

if they react aggressively to a firm that enters its market this may deter potential entrants in the future

The five forces will change over time as market conditions alter. For example, more information is available nowadays to enable customers to compare offerings and prices; this gives buyers more power. The opening up of world markets (for example through the efforts of the World Trade Organisation to reduce protectionist measures that limit trade and the expansion of the European Union enabling free trade between more countries) has led to much more rivalry in markets in recent years. In North America, for example, the sales of Japanese firms such as Toyota have gradually been reducing the market share of American producers such as General Motors as consumers have more choice. Meanwhile, the success of the internet has made it easier for producers to enter many markets such as finance, book retailing and clothes retailing; the ability to start selling online has reduced a major barrier to entry which was the investment required to set up a network of shops. As ever the business world is not static and the conditions in any industry will always be changing. As this happens the various elements of the five forces are always shifting requiring established firms and potential entrants to review their strategies.

APPENDIX D


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