The first of two articles that focus on applying your knowledge of management and strategy to a scenario situation. Part 1 considers the complexities of strategic planning and how they can be broken down into three main areas
One of the main problems faced by Paper P3 students is application of knowledge. Early on in their preparation most students feel comfortable with all that is discussed in Paper P3 and many develop a false sense of security preferring to concentrate on what seems to be an overwhelming amount of information for Papers P2, P4 or P6. It is only when students enter the revision phase do they realise that you need to do much more than just learn the notes in order to pass the exam. The main skill that a student needs to develop is an ability to apply the acquired knowledge in a scenario situation. The following provides an insight into how to apply your knowledge effectively.
This first article deals with the strategic planning process. Many of the various texts on the market comprehensively cover the key processes involved in strategic planning. These often involve comprehensive flow charts with many subparts. Rather than explain these in detail, let us first distil the process into three main areas:
- Strategic analysis.
- Strategic choice.
- Strategic implementation.
Essentially a business will address the following questions:
- Where do we want to go?
- What constraints exist on our resources?
- What are the key threats from the external environment?
Where do we want to go?
The answer to this question is influenced by many factors. Key influencers are often the owners (for example, shareholders) who may have a particular expectation for the organisation. However, one also needs to take into account other stakeholder influences, which could include the government, employees and the general underlying culture of the organisation. These views are very often consolidated into a corporate vision or mission statement.
What constraints exist on our resources?
Resources needed would include finance, plant and machinery and human resources. However, to make it easy, I would recommend that you simply think 6Ms. 6Ms is simply a mnemonic used to save time when thinking about the various resource constraints. It can be summarised as:
The typical questions, which you would ask against each of these resource constraints, would be as follows:
- How much do we have?
- What is the current cost of our capital?
- Is the company excessively geared or are there any opportunities for raising additional finance?
This would refer to machinery in the broadest sense of the word, and typical questions one might ask would include:
- How technically up to date is the machinery?
- Is there a danger of obsolescence?
- Has it been poorly maintained over the years?
- How expensive is our workforce?
- How efficient are our employees?
- Is the business overstaffed?
- Is it understaffed?
- What is the labour turnover rate?
- What is the absence rate?
- Are there good structures to allow management succession?
There is a danger of overlapping with the external environment here, so try to keep to such questions as:
- Are the markets declining/growing?
- Where are new markets emerging?
- How strong are our brands in the current market?
- How expensive are our materials compared to our competitors?
- Do our suppliers have excessive control of materials?
- Do we have favourable access to materials?
- Are our raw materials becoming exhausted?
- What type of structures do we have and are they likely to limit future growth?
- What is the culture of the organisation and will it stifle or fuel future developments?
We will explain later how we can apply these concepts to a case scenario.
What are the key threats from the external environment?
Once we have established constraints on our internal resources we need to assess the threat posed by the external environment. The easiest way to assess the external environment is to use the following two frameworks:
- Porter’s five forces.
- PESTEL analysis.
Porter’s five forces
The American management writer Michael Porter describes the main external competitive threats to be summarised by his five forces model. Essentially, this model determines the level of competition an organisation is facing by assessing the extent to which the five forces are relevant. The five forces are summarised as follows:
- The threat from new entrants.
- The bargaining power of buyers.
- The bargaining power of suppliers.
- The threat from substitute products.
- The extent of competitive rivalry.
1. The threat from new entrants
This is a problem because if competitors can easily enter your business sector they will be able to put a ceiling on your profits. Therefore, the greater the threat from new entrants entering the sector, the higher the levels of competition. The ease which new entrants can enter the business segment is largely determined by the extent of the barriers to entry. You potentially could get a whole Section B question, which goes into detail on barriers to entry.
The following summarises the main barriers to entry.
- Capital cost of entry. The higher the capital cost, the greater the deterrent to someone entering the business and, therefore, the likelihood of competition being less than in industries where it is much cheaper to set up business.
- Economies of scale. This will apply if a substantial investment is needed to allow a new entrant to achieve cost parity. Therefore, anyone entering the segment that cannot match the economies of scale will be at a substantial cost disadvantage from the start.
- Differentiation. Differentiation is said to occur if consumers perceive a product or service to have properties, which make it unique or distinct from its rivals. The differentiation can be in the appearance of the product, its brand name or services attached to the product – for example, Concorde. Therefore, if new entrants are to be successful in entering the market they will need to spend a lot of money on developing the image of the product – hence, they are likely to be put off.
- Switching costs. This is the cost not incurred by a new company wishing to enter the market but by the existing customers. If the buyer will incur expense by changing to a new supplier, they may not wish to change. For example, when the compact disc was invented consumers had to incur a cost of a CD player, as the new compact discs would not work on a conventional record player.
- Expected retaliation. If a competitor entering a market believes that the reaction of an existing firm will be too great then they will not enter the market.
- Legislation. There might be patent protection for a product or the government might only license certain companies to operate in certain segments –
for example, Nuclear Power.
- Access to distribution channels. Existing relationships between manufacturers and the key distributors of the products may make it difficult for anyone else to enter the market.
Therefore, in summary, when thinking about the barriers to entry go through the above list in your planning to see which of them apply. Remember that it is unlikely that they all will apply, but the checklist should ensure that all those that do apply would be picked up.
2. The bargaining power of buyers
Do the buyers of the product have the power to depress the supplier’s prices? If the answer to this question is yes, it is likely that competition will increase. Buyers will have power when:
- they are concentrated and can exert pressure on the supplier
- the buyer has a choice of alternative sources of supply.
3. The bargaining power of suppliers
The extent of supplier bargaining power is very closely linked in with the issues of buyer power. The extent of the power of the suppliers will be affected by:
- the concentration of suppliers: if only a few suppliers, the buyers will have less opportunity to shop around
- the degree to which products can be substituted by the various suppliers
- the level of importance attached to the buyer by the supplier. The switching costs of moving to another supplier.
4. The threat from substitute products
If there are similar products that can be used as substitute then the demand for the product will increase or decrease as it moves upwards or downwards in price relative to substitutes.
5. The extent of competitive rivalry
The most competitive markets will be affected by the previously discussed forces. However they will also be affected by:
- the number of competitors and the degree of concentration
- the rate of growth of the industry
- the cost structures if high – fixed costs prices are often cut to generate volume
- the exit costs. If they are high, firms may be willing to accept low margins so as to stay in the industry.
The other framework, which should be applied when surveying the external environment, is PESTEL factors:
Again, all of these factors will not necessarily apply but provide a useful checklist against which you can compare in an exam situation. They are explained more fully below.
The organisation must react to the attitude of the political party that is in power at the time. The government is the nation’s largest supplier, employer, customer and investor and any change in government spending priorities can have a significant impact on a business – for example, the defence industry.
Political influence will include legislation on trading, pricing, dividends, tax, employment, as well as health and safety.
The current state of the economy can affect how a company performs. The rate of growth in the economy is a measure of the overall change in demand for goods and services. Other economic influences include the following:
- Taxation levels.
- Inflation rate.
- The balance of trade and exchange rates.
- The level of unemployment.
- Interest rates and availability of credit.
- Government subsidies.
One should also look at international economic issues, which could include the following:
- The extent of protectionist measures.
- Comparative rates of growth, inflation, wages and taxation.
- The freedom of capital movement.
- Economic agreements.
- Relative exchange rates.
The social environment
The organisation is also influenced by changes in the nature, habits and attitudes of society.
- Changing values and lifestyles.
- Changing values and beliefs.
- Changing patterns of work and leisure.
- Demographic changes.
- Changing mix in the ethnic and religious background of the population.
The technological influences
This is an area in which change takes place very rapidly and the organisations need to be constantly aware of what is going on. Technological change can influence the following:
- Changes in production techniques.
- The type of products that are made and sold.
- How services are provided.
- How we identify markets.
This concerns issues regarding factors that could impact on the ecological balance of the environment and could include such issues as climate change and pollution
How an organisation does business:
- Law of contract, law on unfair selling practices, health and safety legislation.
- How an organisation treats its employees, employment laws.
- How an organisation gives information about its performance.
- Legislation on competitive behaviour.
- Environmental legislation.
Therefore, when surveying the external environment think through Porter’s five forces and PESTEL factors and you will have a fully comprehensive framework with which you can assess the case.
Past exam-related example
Championsoft is a specialist software house, which has developed and now markets a modular suite of financial software packages under the product name of Champlan. In addition, the company provides a systems design consultancy service to the financial services industry. The company was established in 1988 and the three founding shareholders are also the three full-time working directors. Extracts from the financial results for the last three years are given below. These show declining profitability although aggregate sales revenue has increased year on year.