A company cannot choose a strategy without knowing what is happening around it and what it is good at. A new tax on imports, a rival’s price cut and an ageing machine all matter, but they are different kinds of fact. Strategic analysis sorts them into outside forces and inside strengths, and then asks what to do about each.
This topic covers the tools used to analyse the position before choosing a strategy: PESTEL for the wider environment, Porter’s five forces for the industry, SWOT for the company, the product-based and resource-based approaches to strategy, the four things a strategy must make clear, and the lessons of the PIMS research on market share. The previous topics in this area covered the strategies and how to assess them.
The next covers risk. Neither the May 2014 nor the November 2014 Pathfinder sets a stand-alone question on this topic, but PESTEL and SWOT appear inside many case questions.
In 30 seconds
PESTEL lists the outside factors: political, economic, social, technological, ecological and legal. Porter’s five forces test the attractiveness of an industry: threat of new entrants, bargaining power of suppliers, bargaining power of buyers, threat of substitutes and rivalry among existing firms. SWOT sets internal strengths and weaknesses against external opportunities and threats. A product-based strategy starts from the products and markets.
A resource-based strategy (Hamel and Prahalad) starts from the firm’s core competencies. A strategy should state its product-market scope, competitive advantage, growth vector and synergy. PIMS research found that a large market share and good relative quality raise returns, while heavy capital investment, acquisitions and diversification tended not to.
Key terms in plain English
| Term | What it means |
|---|---|
| PESTEL | A list of political, economic, social, technological, ecological and legal factors outside the company |
| Five forces | Porter’s model of the pressures that decide how profitable an industry is |
| SWOT | Strengths, weaknesses, opportunities and threats |
| Core competence | A skill or resource that gives a firm a lasting advantage |
| Resource-based strategy | Choosing products and markets that use the firm’s strengths |
| Relative quality | Value for money as the customer sees it, compared with competitors |
| PIMS | A research database that links strategy choices to profit and return |
Syllabus check
This topic is in syllabus area B (strategic management, 10% of the marks). It covers:
- analysis of the external environment and of the industry;
- analysis of the entity’s own strengths and weaknesses;
- the approaches used to choose product-market strategy.
CAMA 2020 and strategic analysis
The Companies and Allied Matters Act 2020 (CAMA 2020) is the company law of Nigeria. The sections below apply to this topic.
| Section | What it says | Link to this topic |
|---|---|---|
| s. 308 | A director must use the care, diligence and skill of a reasonably prudent director | Directors must understand the environment before they choose |
| s. 385 | The directors’ report covers performance and risk | It should describe principal risks from the environment |
| s. 404(7) | The audit committee reviews policies and internal control | It reviews how environmental risks are monitored |
PESTEL analysis
PESTEL describes the outside factors that affect a business. ICAN gives these examples:
| Factor | Example |
|---|---|
| Political | A change in government policy reduces the grants available |
| Economic | High interest rates make borrowing for expansion expensive |
| Social | An ageing population raises demand for medicines and care |
| Technological | Touch-screen smartphones replace button phones |
| Ecological | Raw materials such as fish or timber may run out |
| Legal | Environmental and safety laws affect how products are made and sold |
The point of the analysis is to decide which factors matter most and what to do. A factor with a large effect and a high chance of happening needs action. It also supplies the triggers for strategic change, covered in the next topic.
Porter’s five forces
Michael Porter argued that the profit available in an industry depends on five pressures:
- Threat of new entrants: high barriers (large capital needs, strong brands, economies of scale, licences) protect profit. Low barriers invite competitors.
- Bargaining power of suppliers: a few suppliers of a key input can push up prices.
- Bargaining power of buyers: a few large buyers, or buyers who can switch easily, push prices down.
- Threat of substitutes: a different product that meets the same need caps the price.
- Rivalry among existing firms: many equal rivals, slow growth and high fixed costs mean price wars.
If the forces are strong, the industry is less attractive. The company can respond by building barriers, locking in suppliers or buyers, differentiating the product or leaving.
SWOT analysis
SWOT describes the business and its position. Strengths and weaknesses are inside the company. Opportunities and threats are outside it, and often come from PESTEL and the five forces.
ICAN’s examples:
- a strength is a skilled and committed workforce
- a weakness is old machinery that often breaks down
- an opportunity is strong overseas demand for the products
- a threat is a large competitor opening an outlet in the one town where the company is the only supplier
A SWOT list has little value by itself. Use it to match strengths to opportunities, to fix weaknesses that expose the company to threats, and to decide what to do first.
Product-based and resource-based strategy
There are two ways to choose product-market strategy:
- Product-based: decide which products and which markets or segments will be most profitable, and enter them.
- Resource-based: Hamel and Prahalad argued that a firm should first identify its strengths and core competencies and then look for product-market areas that use them. This gives a base for deciding which new areas to enter and is more flexible than a fixed long-term plan.
ICAN gives Amazon as an example. It began as an online bookseller and built a user-friendly website, an efficient delivery service for small parcels and a trusted name. It then used the same competencies to sell CDs, DVDs and other items that are easy to store and post.
Four things a strategy must make clear
- Product-market scope: where the firm will operate.
- Competitive advantage: what will make it win.
- Growth vector: the direction it is moving from its present position.
- Synergy:
the “2 + 2 = 5” benefit of the move, for example making two products on the same equipment or selling two products with the same sales force.
What PIMS research found
The Profit Impact of Market Strategy (PIMS) studies found that a large share of a chosen market tends to bring high returns, so a firm should seek a large share of a market or segment it can lead.
Other findings:
- relative quality matters, and its benefits can cancel the benefit of share if quality is poor
- high investment in capital equipment tends to lower profitability, and the best companies get more sales from each ₦1 invested
- acquisitions have not raised returns for shareholders, and the main winners are shareholders of the acquired company
- diversification has not been particularly successful
The rules in more depth
Why PESTEL and SWOT are used together
PESTEL lists what is changing outside. SWOT asks whether the company is ready for it. A threat in the SWOT usually has a PESTEL source.
Why the five forces suit industry choice
They show where profit goes: to suppliers, to buyers, to new rivals or to substitutes. A firm in a weak industry may do better by changing industry than by working harder in it.
Why a resource-based view helps
Products change quickly. Competencies last longer, so a firm that builds on them can move into new products while keeping its advantage.
Why the PIMS findings carry a warning
They describe averages and do not forecast a single company. They warn against growth for its own sake through costly acquisitions.
Effect on analysis
A good answer picks the few factors that decide the case, ties them to figures in the scenario and says what the company should do.
Worked examples
Example 1: sorting PESTEL factors. A bank is told that (a) the central bank has raised its policy rate, (b) a law requires more customer data protection, (c) more customers now use mobile apps, (d) the government has changed its capital rules.
- (a) Economic. (b) Legal. (c) Social and technological. (d) Political and legal.
- Priority: (a) and (d) affect cost and capital at once, so they need a response first.
Example 2: from SWOT to action. A food processor has a skilled workforce (S), old machines (W), strong demand abroad (O) and a large competitor opening nearby (T).
- Match strength to opportunity: use the skilled workforce to enter export markets.
- Fix the weakness that makes the threat worse: replace the machines so that cost and quality can match the new competitor.
- Rank the actions by effect and cost, and set dates.
Example 3: five forces on an industry. In a market, three large supermarket chains buy from thousands of small farmers. Imports are rising. Entry needs little capital.
- Buyers are strong because they are few and large.
- Suppliers are weak because there are many.
- New entrants are a threat because capital needs are low.
- Substitutes (imports) are a threat.
- The industry is unattractive for farmers. They should join co-operatives, differentiate or sell direct.
Example 4: resource-based choice. A courier firm has a large fleet, trained drivers and a trusted name. Option 1 is to open a restaurant. Option 2 is to offer a same-day delivery service for online sellers.
- Option 1 uses none of its competencies.
- Option 2 builds on them, so it fits a resource-based strategy and is more likely to gain advantage.
How to score full marks
- Use the framework the question names, and add another only if it helps.
- Tie every factor to the scenario and not to the textbook.
- Rank the factors by effect and likelihood.
- Say what the company should do about each important factor.
- Separate internal from external points in a SWOT.
- Link analysis to strategy and to the financial effect.
Common mistakes in the exam
- Listing every PESTEL heading with no link to the company.
- Putting an outside factor in strengths or weaknesses.
- Stopping at the SWOT list without saying what to do.
- Applying the five forces to the company and not to the industry.
- Choosing a strategy that does not use the company’s core competence.
- Quoting PIMS as a rule that applies to every firm.
Quick revision
- PESTEL: political, economic, social, technological, ecological, legal.
- Five forces: entrants, suppliers, buyers, substitutes, rivalry.
- SWOT: strengths and weaknesses are inside; opportunities and threats are outside.
- Resource-based: start from core competencies (Hamel and Prahalad).
- Strategy must state scope, advantage, growth vector and synergy.
- CAMA 2020: ss. 308, 385, 404(7).
Practice questions
These are original questions written in the style of the Institute of Chartered Accountants of Nigeria (ICAN) exam. Try each one before you open the answer. Full model answers follow the written questions.
Recall check: multiple choice
The real ICAN paper has no multiple-choice section. These questions are for quick recall. The written questions that follow are closer to the exam.
Question 1. The E in PESTEL standing for ecological covers:
- Environment such as resource supply and climate
- Employees
- Exchange rates
- Equity
Show the answer
A. Economic is the first E.
Question 2. In SWOT, opportunities and threats are:
- Internal
- External
- Financial only
- Legal only
Show the answer
B. Strengths and weaknesses are internal.
Question 3. Old machinery that often breaks down is a:
- Strength
- Weakness
- Opportunity
- Threat
Show the answer
B. It is an internal shortcoming.
Question 4. Which is NOT one of Porter’s five forces?
- Threat of substitutes
- Power of buyers
- Corporate tax rate
- Rivalry
Show the answer
C. Tax is not one of the five.
Question 5. A resource-based strategy starts from:
- Competitor prices
- Core competencies
- Tax law
- Market share only
Show the answer
B. Hamel and Prahalad.
Question 6. Synergy is described as:
- 2 + 2 = 5
- 2 + 2 = 3
- 1 − 1 = 0
- 5 ÷ 2
Show the answer
A. Combined benefits exceed the parts.
Question 7. The growth vector is:
- The direction of movement from the present position
- A tax measure
- A loan rate
- A type of asset
Show the answer
A. It shows where future growth will come from.
Question 8. PIMS research found that acquisitions:
- Always raise returns
- Did not raise returns for the buyer’s shareholders
- Are tax free
- Reduce risk to zero
Show the answer
B. Target shareholders gained most.
Question 9. Many large buyers with the power to switch suppliers is:
- A weak force
- A strong force on suppliers
- A barrier to entry
- A threat of substitutes
Show the answer
B. Buyer power lowers prices.
Question 10. Which section of CAMA 2020 sets the director’s duty of care and skill?
- Section 308
- Section 400
- Section 405
- Section 409
Show the answer
A. Directors must understand the environment.
Written questions
Question 11 (10 marks). (a) List the six factors in a PESTEL analysis with an example of each. (6 marks) (b) Explain the difference between a product-based and a resource-based strategy. (4 marks)
Question 12 (20 marks). Lagos Foods Ltd processes tomatoes. It has a skilled workforce and old machinery. Three supermarket chains buy most of its output. New imported paste is arriving at lower prices, and the government has announced a tax on imported paste. Overseas demand for local paste is rising. A large competitor has just opened a plant in the same state.
(a) Prepare a SWOT for the company. (6 marks) (b) Analyse the industry using Porter’s five forces. (8 marks) (c) Recommend two strategies, and say how a resource-based view supports them. (6 marks)
Question 13 (10 marks). (a) State the four things a strategy should make clear to outsiders and managers. (4 marks) (b) Summarise four findings of the PIMS research. (6 marks)
Model answers
Show the model answer to Question 11
(a) PESTEL (6 marks). Political: grants reduced after a policy change. Economic: high interest rates make loans dear. Social: an ageing population raises demand for medicines. Technological: smartphones replace button phones. Ecological: resources such as fish or timber may run out. Legal: environmental and safety laws. (1 each)
(b) Approaches (4 marks). A product-based strategy picks the products and markets that look most profitable and enters them. (2) A resource-based strategy starts from the firm’s strengths and core competencies and looks for product-market areas that use them, giving advantage and more flexibility. (2)
Show the model answer to Question 12
(a) SWOT (6 marks). Strength: skilled workforce. (1) Weakness: old machinery, and dependence on three buyers. (2) Opportunities: rising overseas demand; the tax on imported paste. (1.5) Threats: cheaper imports; a large competitor in the same state. (1.5)
(b) Five forces (8 marks). Buyers: strong, because three chains buy most of the output. (2) Suppliers: depends on tomato growers; not stated, so assume moderate. (1) New entrants: a large competitor has already entered, so barriers are not high. (2) Substitutes: imported paste is a close substitute, although the tax reduces the threat. (2) Rivalry: rising with the new plant. (1)
(c) Strategies (6 marks). Market development: sell to overseas buyers, using the skilled workforce and rising demand, which reduces dependence on the three chains. (2) Process investment: replace old machinery to cut cost and match the new plant, after checking the NPV. (2) A resource-based view supports both because each builds on the skilled workforce and processing know-how, which the firm already has. (2)
Show the model answer to Question 13
(a) Product-market scope; competitive advantage; growth vector; synergy. (1 each)
(b) PIMS (6 marks). Any four:
- a large share of a chosen market brings high returns
- relative quality is important
- poor quality can cancel the benefit of share
- heavy capital investment tends to cut profitability
- acquisitions have not raised returns for the buyer’s shareholders
- diversification has not been very successful
(1.5 each, up to 6)
Pathfinder on PESTEL, SWOT, five forces and resource-based strategy
These are the ICAN Pathfinder questions that test this topic. ICAN owns the questions and the suggested solutions, so we point you to them and do not copy them. Open your Pathfinder, attempt each question under exam conditions, then check your answer against the notes above.
Neither the May 2014 nor the November 2014 Pathfinder sets a stand-alone question on this topic. PESTEL and SWOT appear inside case questions on strategy and business plans. Worked examples 1 to 4 show how to apply them.
Revise first: Worked examples
Questions ask you to analyse a scenario with these frameworks. See the sections on PESTEL and SWOT.
Revise first: PESTEL analysis
Source: ICAN Pathfinder, Strategic Financial Management. Diets covered: No stand-alone question in the May 2014 or November 2014 Pathfinder.
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