External Analysis: PESTEL, Five Forces and Industry Life Cycle

When the Covid-19 lockdowns closed dining rooms, a restaurant that already knew the delivery apps could turn itself into a cloud kitchen quickly. One that had watched only its own kitchen started from nothing.

It works at two levels:

• Industry level: the industry's competitive structure, the firm's competitive position, and the industry's dynamics and history.
• Macro level: economic, global, political, social, demographic and technological conditions.

Example. For a kirana store, the industry level covers the new supermarket nearby and grocery delivery apps. The macro level covers rising incomes, digital payments and changing food habits.

Benefits. It encourages growth into new areas. It helps the firm anticipate and adapt to change, as restaurants that turned to cloud kitchens did. And it shows where the firm can set itself apart from competitors.

Environmental scanning, the first step of the strategic management process, is the continuing search for this information.

Don't confuse external analysis with internal analysis. External analysis asks how outside factors, such as industry trends, affect the business; it finds opportunities and threats. Internal analysis looks at the business itself, its resources, processes and culture; it finds strengths and weaknesses. Strategy needs both.

Where it breaks. The future is uncertain, and frameworks give a snapshot of a moving scene. Managers also tend to notice the signals they expect and dismiss the rest.

For exams. The purpose is to find opportunities and threats; scanning is the first step of the strategic management process.

A two-wheeler maker planning five years ahead must ask more than "will buyers like the model?". Subsidies, loan rates, battery costs and emission rules could each change the answer.

It is used in corporate planning and to weigh the pros and cons of a business strategy. The last column applies each factor to the two-wheeler maker, as an illustration.

Using it. List the changes under each factor. Then rank them by how likely each is and how much it would hurt or help. The top few become the opportunities and threats in a SWOT.

Don't confuse political with legal factors. Political factors concern the relationship between business and government. Legal factors are the laws that define what a business may or may not do. They meet when government passes legislation that changes how businesses operate.

Where it breaks. PESTEL is a list, not an analysis. It can produce long lists with no priorities. The factors also interact: a pollution problem (environmental) often becomes a new rule (legal).

For exams. Expand the letters, classify examples into factors, and know which two PESTEL adds to PEST. PESTLE is the same six in another order.

Political, Economic, Social, Technological, Environmental, Legal.

Airlines carry millions of passengers, yet Porter named airlines as an industry where almost no firm earns attractive returns. The reason lies not only in rivals but in four other forces.

Michael Porter set out the model in the Harvard Business Review in 1979. Where the forces are intense, as in airlines, almost no firm earns attractive returns. Where they are mild, as in soft drinks, there is room for higher returns.

Reading the concentration ratio. It is the combined market share of the largest few firms. Suppose, as an illustration, the four largest firms hold 8%, 6%, 4% and 2%:

The four largest firms hold only a fifth of the market, so it is fragmented and rivalry is likely to be intense. If they held 35%, 25%, 15% and 10%, the CR4 would be 85% and a few firms would dominate. As a rough guide, a CR4 of about 40–60% is read as moderate concentration.

Firms can reduce buyer power through loyalty programmes and differentiation, and entry threat by building scale and brand.

A sixth factor: complementors. Some writers add the power of firms that make complements, products that add value to the industry's own. Andy Grove of Intel proposed it as a sixth force; Adam Brandenburger and Barry Nalebuff's Co-opetition (1996) put complementors in their ‘value net’. Weak or unattractive complements can slow an industry's growth. Porter treats complements as a factor that affects the five forces rather than a force of its own.

Don't confuse substitutes with rivals. A rival sells the same product: another airline on the same route. A substitute meets the same need in a different way: a train, a bus, or a video call instead of the trip.

Where it breaks. The model is a snapshot, and industry boundaries are often unclear. It treats other firms mainly as threats, which is why complementors were added. It also explains industry profit, not why one firm in the industry beats another.

For exams. Name the five forces, say what makes each stronger, and know the debate over complementors as a sixth force.

Entrants, suppliers, buyers, substitutes, rivalry.

Price cuts that win customers while a market is growing fast can start a ruinous price war once growth stops. The right move depends on how old the industry is.

The simple version has four stages: introduction (low sales, high costs), growth (rising sales and profits, new entrants), maturity (saturation) and decline (falling demand, firms leave). Profitability usually peaks in growth and maturity.

Charles Hill and Gareth Jones describe five stages and what each means for competition.

Example. Picture a new kind of product whose sales are climbing fast. Many start-ups enter, yet all of them grow, because demand is rising. When growth slows, the same firms fight over a market that has stopped expanding. That is the shakeout.

Don't say the threat of entry is low in the growth stage. It is a common mistake. In Hill and Jones's account it is at its highest then, though fast growth keeps rivalry low. Also, don't confuse the industry life cycle with the product life cycle: one describes a whole industry, the other a single product.

Where it breaks. Stages vary in length, and the turning points are clear only afterwards. Some industries never follow the curve, because new technology renews demand. Firms' own moves can also speed up or delay a stage.

In practice. In growth, invest to build scale and brand before the shakeout. In maturity, segment and protect margins. In decline, choose between leading the remaining market and leaving early. For exams, learn the five stages and the entry threat and rivalry in each.

Embryonic, growth, shakeout, maturity, decline.