Business

Friday May 15, 2009

Analysis of companies’ internal and external environment vital

Whose Business Is It Anyway - A column by John Zinkin


SWOT test to decide on right strategy

My last article pointed out that boards are involved in the five stages of setting, reviewing and adopting strategies.

Today I begin with the second stage: scanning the company’s internal and external environment as part of deciding what strategy to adopt. Simply put, this requires boards to do a SWOT (strengths, weaknesses, opportunities and threats) analysis to assess the strengths and weaknesses of their companies by looking internally; and at the same time evaluate the opportunities and threats surrounding their companies by looking externally.

External analysis should also include a review of Porter’s Five Forces – a framework examining the sources of competition for available market margin; and also take into account political, economic, social, technical, legal and environmental (PESTLE for short) influences on their companies.

For more sophisticated boards, PWC’s board tool kit includes more frameworks: SIPOC analysis which includes suppliers, inputs to company processes, the processes, the outputs of such processes and customers; the critical to quality (CTQ) diagnostic tree; current situation analyses and scenario planning.

This article deals with SWOT only.

People normally talk about SWOT. Personally I prefer TOWS, or SWOT backwards. The reason is simple. TOWS begins by forcing boards to look outside companies at the current and future threats they face.

In my view, it is crucial to understand threats first and the downside they represent, as this allows boards to think of what they must have in place to survive should the worst happen. Never has it been more important to think this way, given the current economic outlook. Thinking about threats prevents companies from becoming complacent and stops them resting on their laurels.

Opportunities

Opportunities are wonderful because they encourage boards to think optimistically about the future and offer areas of growth. But opportunities are also profoundly dangerous especially if boards do not really understand what needs to be done to take advantage of them.

Some of the biggest failures of corporate governance have come from boards looking at opportunities, without understanding the associated risks, and entering new lines of business, which have nearly bankrupted the business when they have gone wrong.

Cases in point are AIG, UBS and Citigroup which entered into derivatives they did not understand, but which were growing fast and yielding fat fees.

Weaknesses

Weaknesses come in many shapes: they can be lack of finance, skills or processes and they only show up when the company gets “stress-tested”, either by reality or through simulation. Boards therefore should test the assumptions that underlie any strategy rigorously, thinking the unthinkable to highlight potential areas of weakness so that they can be rectified before they matter.

Exploring different scenarios is particularly useful in making boards think through what happens to companies when things go wrong and weaknesses become critical. But how often do boards take the time to stress-test their assumptions, their resources and their processes? Not often enough.

Sometimes apparent weaknesses can in fact, be hidden strengths, as in karate. Dell’s success, as a newcomer, in building its business against HP, Compaq and IBM was the result of an apparent weakness. They had strong dealer networks – traditionally regarded as an insuperable barrier to entry for a newcomer like Dell, with none. Dell turned this weakness into strength by developing a business model that did away with dealers altogether, turning its competitors’ strength into a weakness.

Boards should only look at strengths after they have evaluated threats, opportunities and weaknesses, for this provides necessary context in which to assess whether past strengths still are a source of competitive advantage, as in the case of HP and IBM when dealing with Dell, or whether they have become a legacy that gets in the way of making urgent changes.

Just as weaknesses come in many forms, so do strengths. They can be: deep pockets allowing companies to take risks others cannot or to survive downturns because the balance sheet can stand them; unique skills across the value chain that bring superior, differentiated products to market faster than competitors; lower costs with better value propositions; or unique branding. However, these are the result of core competences – rare, difficult to copy things that companies have mastered making how they create value unique. More often than not, they are part of the tacit knowledge employees have: how to do things, the timing and processes adopted that outsiders cannot emulate, however hard they try. Nobody else can make Coke or Nutella, despite all the reverse engineering and spectral analysis by competitors. Coke and Nutella are the real thing; their competition, pale copies. The same is true of luxury designer brands.

As boards evaluate strategies, they must consider external and internal environments to see if there is balance between threats and opportunities, and if strengths and weaknesses are in favourable equilibrium, before deciding which to choose.

  • John Zinkin is CEO of Securities Industry Development Corp, the training and development arm of the Securities Commission. Readers’ feedback is welcome. Please email starbiz@thestar.com.my

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