Evaluating the External Environment

Evaluating the External Environment

A Report/Essay by George Blekas

Skopje, 2005

1

Abstract

The case study presented hereby addresses the survival and prosperity of a telecom oriented firm in a quite contracted market. This is being analyzed by investigating the economic factors affecting directly (microenvironment, microeconomics, etc) or indirectly (macroeconomics, global conditions, etc) the firm along with the impact of the market structure and the competition. Countermeasures are being investigated to compensate critical issues such as competition, and attention is being drawn to competitive strategies such as diversification and differentiation.

2

Contents

1.

Introduction

p.4

2.

Company Profile

p.4

3.

Microenvironment

p.5

4.

Market Structure

p.7

5.

Competition

p.8

6.

Microeconomics

p.9

7.

Macroeconomics

p.10

8.

Regulations

p.12

9.

Global Conditions

p.13

10. Competitive Strategy

p.14

11. Literature Overview

p.16

3

1) Introduction

A Business Economics approach to a firm produces valuable findings in crucial domains such as microeconomics, market, competition, strategy, etc. All of these can, and should, be carefully taken into consideration in order to steer the firm accordingly and to avoid potential pitfalls. In other words decisions to be made are needed in various phases of any firm’s course. A Business Economics Analysis will result higher possibilities of reaching the desired target.

2) Company Profile

Parallax Ltd (the Firm) has been founded on 2002 in FYR Macedonia as a Telecommunications Service Provider (providing Turn-Key solutions to Telecommunication Operators). Its initial objective was to implement the GSM network of the second mobile operator in the country within a limited time frame and maintain the needed high standards concerning provided services. A couple of years afterwards, having successfully achieved its initial goal, the Firm has been reformed from a single project to a multi project company.

The Firm consists of a team of 46 employees: 2 expatriated managers, 6 local managers 36 local experts in the fields of Electrical Engineering and Telecommunications, Mechanical Engineering, Architecture, Civil Engineering, Business Administration and Economy, etc. The current Organizational Chart can be found on Appendix 1.

4

3) Microenvironment

Considering the factors in proximity to the Firm’s operation Porter (1979) analyzed these utilizing a Five Forces scheme according to which the market is being defined by the following factors (forces according to Porter): I. Rivalry among existing Competitors II. Threat of new Competitors III. Bargain Power of Customers IV. Bargain Power of Suppliers V. Products that can be used as Products’ Substitutes

The Firm operates within the Telecommunications Industry. Taken into consideration Porter’s Five Forces an analysis follows: I. The Firm, after being a multi-project company, is facing the competition of existing firms being addressed to the telecom market, some of which are/have been its subcontractors. In the latter case a delicate balance has to be maintained in order to assure that companies which are functioning as subcontractors of the Firm will not address the final customer directly; II. New competitor considering entering the market are mainly being discouraged by technological barrier of entry: quite advanced technological know-how is needed to penetrate the market and assure survival; III. The Customer didn’t possess such a bargain power in the beginning due to constrains such as the time frame for the implementation of its project and the existing local telecom lobbies opposing its

5

activities, both of which automatically were addressing the need for the creation of the Firm. After its successful establishment (launch of services) and presence for a couple of years, customer had the time to focus on its internal organization and thus investigating the market further which increased its bargain power; IV. Similarly the Bargain Power of the Firm was significant in the beginning but was diminished by the fulfillment of the project as the customer was turning more from timely-implementation-sensitive to price-sensitive. The quality-sensitive aspect has however still significant weight for the customer and thus the Firm is focusing there; V. As a result substitutes do exist at the present time since the market has been liberated quite a lot (see analysis below).

Porter (1998) stated “…basic types of competitive advantage a firm can possess: low cost or differentiation” (p.11). In our case the Firm has chosen to prioritize on assurance of high level of value added on services provided (directly or through subcontracting) and thus pursuing and achieving a differentiation competitive advantage. Although cost-wise the market provides other alternatives than the Firm, differentiation has been the pillar upon which the Firm is mainly relying on for its prosperity. Due to market pressure there were occasions in which the Firm was “forced” to back-off price wise (i.e. reduce its mark-up) in order to maintain its strategic position.

6

4) Market Structure

The market structure can be defined as a set of organizational features which have significant influence on the nature of competition (Bain, 1959). According to Moschandreas (2000) these include Product Differentiation, Concentration, Barriers to Entry, Economies of Scale, and Vertical Integration & Diversification. These features have been respectively addressed by the Firm by: •

Providing the adequate added value for every product (service). That is, among other, quality assurance and fast implementation of services;

•

Addressing, at the beginning at least, its products to a new entrant in the market and thus avoiding existing collusions on the previously established monopolistic market;

•

Providing advanced know-how which the local market lacked (or was operating under colluded interests at the point entry occurred);

•

Economies of scale, considering the business nature, are not applicable, at least not up to a significant extent, since the main product is specialized telecom services. Instead economies of scope should be considered since the Firm re-adapts its product portfolio according to customer needs (demand side changes). Furthermore, and as Montgomery C. and Porter (1991) suggested, “Scope economies are derived from activities in interrelated markets. If they are strong, a sustainable advantage in one market can be used to build sustainability in another.” This constituted the Firm’s practice in expanding to neighboring markets and thus achieving a competitive advantage;

•

While initially subcontracting was enormous, soon it has been vertically integrated into the firm. Similarly diversification has been achieved by

7

provision of 24hours/7Days support services along with other value added services.

5) Competition

Existing competition, upon entrance of the Firm in the market, was limited and furthermore colluded with the first mobile telecom operator. That forced the customer (the second mobile telecom operator) to choose the Firm as its major supplier.

Ackoff (1999), in discussing monopolistic suppliers, state that: “…if a company uses only one supplier and show reluctance to use any other one, a virtual monopoly is created. It is for this reason that it is often a good idea to have at least two different suppliers of any heavily used resource.” (p.145). Consequently after the implementation of the vast volume of the customer’s project, competition started manifesting itself.

A particularity the Firm deals with is that companies to which the Firm is contracting out might become future competitors by bypassing the Firm and address the final customer directly. The approach of the Firm to this was to limit know-how leakage as much as possible and, additionally, to divide/distribute subcontracting as much as feasible. Additionally the final quality control and assurance, along with the required documentation to be delivered to the customer, has been kept under direct control of the Firm.

8

As far as future competition is in question Porter (1980) stated that this can be categorized as following: I. Companies which can overcome entry barriers II. Companies for which synergy for being into the market exists III. Companies entering as an extension of their corporate strategy IV. Companies emerging (or being strengthen) due to mergers or acquisitions V. Customers and/or suppliers who may integrate backward or forward The Firm has already experienced customer’s vertical integration, and thus reduction of outsourcing. Additionally it is experiencing competition due to synergy issues. These were also the causes for the Firm pursuing alternative projects to assure its profitability.

6) Microeconomics

According to Mabry and Ulbrich (1994) the basic economic questions are What, How, and for Whom to produce. In terms of microeconomic factors these are being defined by the three major microeconomic goals of Economic Efficiency, Distributional Equity and Economic Freedom which are sequentially being addressed by the Allocative Efficiency (What), Production Efficiency (How) and the Distributional Equity (for Whom).

In reverse order:

9

VI. The firm originally operated in a “virtual monopoly” (Ackoff, 1999) since it had to deal with only a single client and thus no further analysis were needed in order to specify to Whom its products will be addressed to; VII. Had to balance issues concerning How to produce, and thus has chosen a proper ratio of outsourcing (subcontracting) along with direct production. The latter has been estimated to be of fundamental importance in order to assure quality at the maximum of its extent. Capital (technology) versus labor has been also taken into consideration; VIII. Last, but not least, the Firm had to prioritize in which products to focus the most (i.e. civil works, telecom works, legalization services, etc). It did so by balancing the revenues of its product (service) but mostly according to customer needs.

7) Macroeconomics

This time, and while microeconomics are dealing with the details of the big picture (Schiller, 2006), focus is being drawn to the big picture itself. The later had quite a few “wrinkles” relatively recently. The country experienced periods of economic instability, due to its secession from Yugoslavia on 1991, to the war in its neighboring borders with Kosovo on 1998 and finally the internal security crisis on 2001. All of these had their impact to the peace dividend while, according to World’s Banks GDP Growth data, 1991’s and 2001’s crises were the ones severely impacting the economy (see Appendix 2)

10

The three major macroeconomic goals of Economic Grow, Full Employment and Price Stability, are addressed by the government in its Economic Program where it is stated that “The general consensus for progress of the Republic of Macedonia towards the European Union and accepting its values and standards determines the sustainable economic growth and opening of new jobs to be a priority objective of the macroeconomic policy, without neglecting the prices stability” (2005). “Inflation in Macedonia is way below the level of inflation seen in the EU countries” (United Nations Development Program, 2004). So the government itself emphasizes on the major issue of unemployment which has lately drawn a lot of attention since its official rate has raised to 38,6% (FYR Macedonia State Statistical Office, 2005). As Petreski (2005) argues “Persistently high unemployment, more than the low income, is the key factor of poverty” which according to FYR Macedonia State Statistical Office is 29,6% (2004).

Countermeasures are being taken and thus a “National Employment Policy Conference was held in Skopje, organised in close cooperation with the Ministry of Labour and Social Policy and the Employment Service Agency. The main objective was to increase understanding of employment policy development and provide an overview of the challenges in developing and implementing a National Action Plan for Employment according to the EU model.” (European Agency for Reconstruction, 2005). Government’s policy has been reinforced by major stability orientated institutions/organizations such as the European Bank for Reconstruction and Development, which had “signed over 24 investments… totaling just over €381 Million” (EBRD, 2005), and the World Bank which has “Overall commitments for active projects total $84 Million” (2005). Inline major

11

funds have been committed to Micro, Small and Medium Enterprises in an attempt to suppress the unemployment rate (EBRD, 2005).

Government expects, as part of its 2005-2007 Fiscal Strategy, the “urgent stoppage of unemployment growth and restoration of the disturbed labour market functions” (2005)

8) Regulations

FYR Macedonia used to operate below the socialistic political doctrine umbrella and thus; the type of regulation diffused over its market, was governmental-type monopolies which were present on various market areas (Telecom, Energy, etc). During the past years, and after some political transition and the consequent delay to reach stability, the government proceeded to pursue a market expansion through privatization and thus introduced regulation changes to accommodate new entries in markets so far dominated by state monopolies. As a result legislation has been revised in order to accommodate such changes.

Hilke (1993) presented a compilation of study findings concerning cost savings from privatization where a wide variety of reasons of cost savings are mentioned accompanied by numerous independent studies. However “the importance of regulation, monitoring and enforcement of security trading in economies-in-transition” (Castater, 2002) is necessary to be borne in mind. Furthermore, Castater emphasizes that “privatization alone, despite changes in other economic reforms, tends to cause an increase in regulation overall.” and

12

thus indirectly increasing privatization’s final cost. From the social point of view Beesley (1997) argues about “…reform industries, while meeting social needs.” and continues that “Privatization, properly designed, makes it possible to decouple the two tasks, and to focus social policy more effectively.”

9) Global Conditions

Following the aforementioned argumentations it is obvious that microeconomics is being affected by macroeconomics which, in turn, is broken down to country level, coalition level (such as the European Union) or, at last but not least, global level influence. According to World Bank (2000) “Globalization can be summarized as the global circulation of goods, services and capital, but also of information, ideas and people.” There are plenty of examples on both sides of economy – expansion or contraction – where it is obvious that an interaction with global conditions is in place, varying its level depending on the case. Following these there are some critical factors which may heavily influence most – if not all – markets.

One of this is the Energy market which literarily constitutes the driving forces of all industries. “Through its use in the production of intermediate goods, shocks to the price of energy affect the supply capacity and output prices in the traded and non-traded intermediate goods sectors”. Following this “…large increases in energy prices can generate an inflation response.” (Hunt, 2005)

13

Another factor which has drawn a lot of attention lately is Terrorism. Someone might argue that the local region where the Firm is deploying its activities is not likely to suffer from such an incident but one needs to keep in mind the indirect effects such as impact on oil price, USA economy impact consequently impacting – up to an extend – the world economy (World Bank, 2003)

10) Competitive Strategy

The Firm pursues its competitive advantage by product differentiation and diversification. Differentiation has been achieved by focusing on the value added on its services (see chapter 2). Additionally it has achieved diversification by becoming active in other areas apart from its main one – the telecom business. Thus it has entered the Designing domain, the Construction domain, and the Legalization domain as some extension of its Telecom services. Further more instead of simply providing the aforementioned services as stand-alone it provides them as services bundles: design and construction or design and legalization or design, legalization and construction as compete turn-key solution. By being active in various domains the Firm is able to swiftly shift its activities in order to accommodate different market needs and thus “enjoy reductions in mobility barriers because of opportunities for sharing operations or functions” (Porter, 2004).

Furthermore, and since the various local market areas are being privatized (telecom, energy, etc), the Firm is investigating other diversification possibilities which are being forwarded to its parent company for further analysis and

14

evaluation, possibly resulting in some major future investment/diversification. Moreover penetrating new markets (in term of geographical region) has been practiced severely since the local market is quite limited. These goals are being pursued since the Firm’s capabilities have exceeded the local market needs and thus either a market expansion or the Firm’s contraction is needed.

15

11) Literature Review

Published Literature (Books) •

Ackoff, R. (1999) Re-Creating the Corporation: A Design of Organizations for the 21st Century. Oxford University Press.

•

Bain, J. (1959) Industrial Organization. New York, Wiley.

•

Beesley, M. (1997) Privatization, Regulation and Deregulation. Routledge.

•

Porter, M. (1979) How competitive forces shape strategy. Harvard Business Review 57(2), p. 137-145.

•

Porter, M. (1998) Competitive Advantage: Creating and Sustaining Superior Performance. Free Press.

•

Porter, M. (2004) Competitive Strategy: Techniques for Analyzing Industries and Competitors. Free Press.

•

Mabry, D. and Ulbrich, C. (1994) Economics. London, Houghton Mifflin.

•

Montgomery C. and Porter M. (1991) Strategy: Seeking and Securing Competitive Advantage. Harvard Business School Press

•

Moschandreas, M. (2000) Business Economics. Business Press Thompson 2000

•

Schiller B. (2006) The Economy Today. New York, Mc Graw Hill

Online Literature/Sources •

Castater, N. (2002) Privatization as a Means to Societal Transformation: An Empirical Study of Privatization in Central and Eastern Europe and the Former Soviet Union.[online].Fondazione Eni Enrico Mattei. Available from: http://www.feem.it/Feem/Pub/Publications/WPapers/WP2002-076.htm [Accessed 17th December 2005]

16

•

European Agency for Reconstruction (2005) Quarterly report to the European Parliament: January to March 2005.[online].European Agency for Reconstruction.

Available

from:

http://www.ear.eu.int/macedonia/macedonia.htm [Accessed 17th December 2005] •

European Bank for Reconstruction and Development (2005) EBRD activities in

FYR

Macedonia.[online].EBRD.

Available

http://www.ebrd.com/pubs/factsh/country/mace.pdf

[Accessed

from: 17th

December 2005] •

FYR Macedonian Government (2005) Economic Program.[online].FYR Macedonian

Government.

Available

from:

http://www.vlada.mk/Assets/EKONOMSKA%20PROGRAMA-ang.DOC [Accessed 17th December 2005) •

FYR Macedonian Government (2005) 2005-2007 Fiscal Strategy of Republic of Macedonia.[online].FYR Macedonian Government. Available from: http://www.finance.gov.mk/gb/download/fiscal_strategy_2005-2007.pdf [Accessed 17th December 2005]

•

FYR Macedonia State Statistical Office (2004) Poverty in Republic of Macedonia.[online].FYR Macedonia State Statistical Office. Available from: http://www.stat.gov.mk/pdf/1-2005/4.1.5.56.pdf [Accessed 17th December 2005]

•

FYR Macedonia State Statistical Office (2005) Indicators.[online]. FYR Macedonia

State

Statistical

Office.

Available

from:

http://www.stat.gov.mk/english/glavna_eng.asp [Accessed 17th December 2005]

17

•

Petreski G. (2005) Unemployment and Growth in the Republic of Macedonia.[online].FYR Macedonia Ministry of Finance: Bulletins. Available from: http://www.finance.gov.mk/gb/bulletins/05-06-05/goce_petrevski_a.pdf [Accessed 17th December 2005]

•

United Nations Development Program (2004) Early Warning Report: November 2004.[online].United Nations Development Program. Available from:

http://www.undp.org.mk/Publication/EWNov2004Eng.pdf

[Accessed

17th December 2005] •

World Bank (2005) Country Brief.[online].World Bank. Available from: http://www.worldbank.org.mk/WBSITE/EXTERNAL/COUNTRIES/ECAEXT/ MACEDONIAEXTN/0,,menuPK:304482~pagePK:141132~piPK:141107~the SitePK:304473,00.html [Accessed 17th December 2005]

•

Hilke, J. (1993) COST SAVINGS FROM PRIVATIZATION: A Compilation of Study

Findings.[online].Available

from:

http://www.reason.org/htg06.pdf

[Accessed 18th December 2005] •

World Bank (2000) Poverty in an Age of Globalization.[online].World Bank. Available

from:

http://www1.worldbank.org/economicpolicy/globalization/documents/povrtygl obalization.pdf [Accessed 18th December 2005] •

Hunt, B. (2005) Oil Price Shocks: Can They Account for the Stagflation in the

1970s?.[online].International

Monetary

Fund.

Available

http://www.imf.org/external/pubs/ft/wp/2005/wp05215.pdf

[Accessed

from: 18th

December 2005] •

World Bank (2003) Global Economic Prospects and the Developing Countries.[online].The

International

Development

The

/

World

18

Bank

for

Bank.

Reconstruction Available

and from:

http://siteresources.worldbank.org/INGEP2003/Resources/gep2003complete .pdf [Accessed 18th December 2005]

19

APPENDIX 1

General Manager Technical Manager

Quality Representatives 

Technical Department 

Construction Department 

 

 

Legal Adviser 

IT  Department 

Marketing & Sales  Department 

Finance Department 

Field Engineers   Section 

Legalization & Site  Acquisition Section 

Accounting  Section 

Installation  Section 

Installation Engineering Section 

Procurement  Section 

Field Engineers  Section 

Warehouse

Technicians Section 

20

HR & Administration  Department 

APPENDIX 2

World Bank (2005)

21