2. Managers in the airline industry have their work cut out for
them; they face one of the most challenging environments
in business. Since 2001 this industry has been
characterized by volatile demand conditions and intense
competition from low-cost carriers such as Jet Blue, Air
Tran, and Southwest Airlines. Consumers have plenty of
options to choose from, and they tend to select carriers with
the lowest prices, putting downward pressure on pricing.
When adjusted for inflation, the price consumers paid to fly
one mile in the United States fell from $0.091 in 1980 to
$0.042 in 2004. Moreover, the cost structure of airlines is
closely linked to volatile fuel prices. Every 5 percent
increase in fuel costs reduces airline profitability by 1
percent, and the price of jet fuel increased from $0.71 a
gallon on average in 2002 to $1.80 a gallon in late 2005. To
complicate matters, many long-established airlines also
have to work with powerful labor unions that historically
have resisted attempts to reduce employee pay and
introduce flexible work processes. This has kept labor costs
high. Due to these conditions, between 2001 and 2004 the
3. The work of all managers is affected by two
main environments:
1. the external environment
2. the internal environment.
4. EXTERNAL ENVIRONMENT
It constitutes everything outside a firm that
might affect the ability of the enterprise to
attain its goals.
The external environment itself can be
subdivided into two main components.
Industry or task environment
General environment
5. INTERNAL ENVIRONMENT
The internal environment constitutes
everything inside the firm that might affect the
ability of managers to pursue certain actions
or strategies.
includes the organization of the firm (its
structure, culture, controls, and incentives),
the employees of the firm (its human capital),
and the resources of the firm (its tangible and
intangible assets).
6.
7. A. THE TASK ENVIRONMENT
One of the most popular frameworks for
analyzing the task or industry environment is
a model developed by Michael Porter known
as the five forces model.
According to Porter, the ability of a firm to
make a profit is influenced by five
competitive forces
That are:
8. the threat of entry by potential competitors,
the power of buyers, the power of suppliers,
the threat of substitute products, and the
intensity of rivalry between firms already in
the industry.
9. (I) THE THREAT OF ENTRY
In general, if an industry is
profitable new enterprises will enter,
output will expand, prices will fall,
and industry profits will decline.
Managers often strive to reduce the
threat of entry by pursuing
strategies that raise barriers to
entry.
10. Barriers to entry are factors that
make it costly for potential
competitors to enter an industry and
compete with firms already in the
industry.
Economies of scale
Brand loyalty
11. (II) BARGAINING POWER OF BUYERS
The next competitive force is the bargaining
power of buyers.
An industry’s buyers may be the individual
customers who ultimately consume its
products (its end users) or the intermediaries
that distribute the industry’s products to end
users, such as retailers and wholesalers.
12. For example, although detergents made by
Procter & Gamble and Unilever are ultimately
purchased by individual consumers, the
principal buyers of detergents from P&G and
Unilever are supermarket chains and
discount stores, which then resell the
products to consumers.
13. Demanding lowering prices & better service,
powerful buyers can squeeze profits out of an
industry.
Thus powerful buyers should be viewed as a
threat.
Alternatively, when buyers are in a weak
bargaining position, firms in an industry may
have the opportunity to raise prices and
increase the level of industry profits
14. (III) BARGAINING POWER OF SUPPLIERS
Suppliers provide inputs to the firm.
These inputs may be raw materials,
partly finished products, or services.
Whether suppliers represent an
opportunity or threat to a firm depends
on the extent of their control over inputs
the firm needs to function.
15. In the extreme case, where there is only a
single supplier of an important input, that
supplier has substantial bargaining power
over the firm and can use this power to raise
input prices and increase costs.
Such a situation constitutes a threat.
In the personal computer industry, where
chip maker Intel has long been the dominant
supplier of microprocessors to personal
computer makers.
16. (IV) THE THREAT OF SUBSTITUTES
substitute products are the goods or
services of different businesses or industries
that can satisfy similar customer needs.
For example, firms in the coffee industry
compete indirectly with those in the tea and
cola drink industries because all three serve
customer needs for nonalcoholic caffeinated
drinks.
17. The existence of close substitutes is a strong
competitive threat because this limits the
prices that companies in one industry can
charge for their products, and thus industry
profitability.
If the price of coffee rises too much relative
to that of tea or cola, coffee drinkers may
switch to those substitutes.
18. (V) INTENSITY OF RIVALRY
Last in Porter’s model is the intensity of
rivalry between firms in an industry.
Intense rivalry between firms, such as we
currently see in the airline industry, is a threat
that reduces the profits of established
enterprises.
A number of different factors determine the
intensity of rivalry in an industry: demand and
supply conditions, and the cost structure of
firms.
19. (A) DEMAND AND SUPPLY CONDITIONS
If overall customer demand for a product or
service is growing, the task environment can
be viewed as more favorable.
Firms will have the opportunity to expand
sales and raise prices, both of which may
lead to higher profits.
Of course the converse also holds: Stagnant
or falling demand is a threat that leads to
lower profits.
20. (B) THE COST STRUCTURE OF FIRMS
Fixed costs are those that must be borne
before a firm makes a single sale.
For illustration, before they can offer service,
cable TV companies have to lay cable in the
ground; this is a fixed cost.
In industries where the fixed costs of
production are high, if sales volume is low,
firms cannot cover their fixed costs and will
not be profitable.
21. This creates an incentive for firms to cut their
prices and increase promotion spending to
raise sales volume, thereby covering fixed
costs.
In situations where demand is not growing
fast enough and too many companies are
cutting prices and raising promotion
spending, the result can be intense
competition and lower profits.
Thus high fixed costs should be viewed as a
threat, particularly when combined with weak
demand conditions or excess capacity.
22. THE GENERAL ENVIRONMENT
general environment is the larger
environment within which the task
environment is embedded.
Elements in the general environment impact
the organization through the medium of the
task environment.
23. A. POLITICAL AND LEGAL FORCES
Political processes shape a society’s laws,
which constrain the activities of organizations
and thus create both opportunities and
threats.
Industry-specific regulators are
government agencies with responsibility for
formulating, interpreting, and implementing
rules specific to a particular industry.
Contd..
24. Rules shape competition in an industry;
thus government regulators can have a
profound impact on the intensity of
competition in a firm’s task environment
and on the opportunities and threats
confronting its managers.
25. B. MACROECONOMIC FORCES
Macroeconomic forces affect the general
health and well-being of a national or the
regional economy, which in turn affect the
profitability of firms within that economy.
Four important factors in the macroeconomic
environment are the growth rate of the
economy, interest rates, currency
exchange rates, and inflation (or deflation)
rates.
26. C. DEMOGRAPHIC FORCES
Demographic forces are outcomes of
changes in the characteristics of a population,
such as age, gender, religion and social
class.
Like the other forces in the general
environment, demographic forces present
managers with opportunities and threats and
can have major implications for an
organization.
27. D. TECHNOLOGICAL FORCES
Over the last century the pace of
technological change has accelerated.
This has unleashed a process that has been
called a “creative destruction.”
Technological change can make established
products obsolete overnight and
simultaneously create a host of new product
possibilities.
28. E. INTERNATIONAL FORCES
The last half century has witnessed
enormous changes in the world
economic system.
Economic growth in places like Brazil,
China, and India is creating large new
markets for goods and services, giving
enterprises an opportunity to profit by
entering these nations.
29. 2. THE INTERNAL ENVIRONMENT
In addition to the external environment,
managers also face the internal
environments of their own organizations
the internal environment includes the
organization of the firm (its structure, culture,
controls, and incentives), its employees
(human capital), and its resources (tangible
and intangible assets).
30. Each of these elements can be a
strength, enabling managers to attain
the goals of the enterprise, or a
weakness that makes it more difficult for
managers to work productively toward
attaining enterprise goals.
This inward focus complements the
identification of opportunities and
threats in the external environment.
31. A. INTERNAL ORGANIZATION
The internal organization of a firm can create an
environment that is easy or difficult to work in.
It might be an enlightened meritocracy that
offers a host of opportunities for advancement,
rewards skilled and creative managers, and
fosters high productivity;
or it might be an inert bureaucracy that punishes
those who advocate change, rewards only those
who promote the status quo.
32. Organization structure defines who has
responsibility for what in an organization,
where power and influence are concentrated
in an organization, and thus whose support is
critical for getting things done.
Controls and incentives tell the manager
what kind of behavior the organization
expects, what is being tracked, and what will
be rewarded.
33. An internal organization that encourages and
rewards high productivity and enables
managers to respond rapidly to external
opportunities and threats can be considered
a strength.
34. B. EMPLOYEES (HUMAN CAPITAL)
The employees of an enterprise can be a
source of sustained competitive advantage,
or they can represent a weakness.
Employees constitute what economists call
the human capital of an organization, by
which they mean the knowledge, skills, and
capabilities embedded in individuals.
Human capital is a crucial source of
productivity gains and economic growth.
35. People can be a distinctive strength or a
weakness relative to competitors;
managers can exert influence over the
human capital of the organization
through human resource practices and
by putting the right internal organization
architecture in place.
36. C. RESOURCES
Resource-based view of the firm
argues that the resources of an
enterprise can be a source of
sustainable competitive advantage.
The resources of a firm are the assets
that managers have to work with in their
quest to improve the performance of the
enterprise.
37. Tangible resources are physical assets,
such as land, buildings, equipment,
inventory, and money.
Intangible resources are nonphysical
assets that are the creation of managers and
other employees, such as brand names, the
reputation of the company, processes within
the firm for performing work and making
decisions, and the intellectual property of the
company
38. The resource-based view argues that a
resource can constitute a unique strength if it
meets the following conditions:
(i) First, the firm must own the resource
(ii) the resource must be valuable
(iii) the resource must be rare
(iv) the resource must be inimitable (unique)
(v) the resource must be non-substitutable
39. For a simple example, consider Aramco, the state-
owned Saudi oil company. Aramco owns a valuable
resource: the sole right to pump oil out of the giant
Saudi Ghawar field, the largest ever discovered. The
resource is valuable because the cost of extracting oil
from Ghawar, at around $10 a barrel, is far below the
price of oil (which in early 2006 stood at $70 a barrel).
The resource is rare because very few oil fields are
as big as Ghawar, and the cost of oil extraction at
Ghawar has long been among the lowest in the
world. The resource is inimitable because other oil
companies cannot simply copy the Ghawar—there is
only one Ghawar. The resource is nonsubstitutable
because there is no other way of producing oil that is
substitutable for production at Ghawar. Thus
ownership of the right to pump oil out of Ghawar
represents a unique strength of Aramco.
