Environment and ecosystem

1 The organisational ecosystem

Every organisation inhabits an ecosystem: the community of customers, suppliers, competitors, complementors, regulators, investors and wider society among which it operates, adapts and evolves. The ecosystem has its markets, its players, its ‘rules of the game’ and its own systems of governance. You met the concept in E2; in E3 the question is sharper — how does the ecosystem shape strategy, and what strategic use can an organisation make of it?

It helps to distinguish three senses of the word:

• The wider ecosystem — everything that surrounds the organisation: markets and competition on one side, society and regulation on the other. Society grants organisations their ‘permission to play’ — regulation, licences and public acceptance — and can withdraw it.

• Industry ecosystems — the players and interdependencies of a particular industry: its suppliers, distribution channels, complementary products, standards and conventions, and its characteristic sources of disruption.

• Deliberate (smaller) ecosystems — networks that organisations consciously join or build to pursue their strategic preferences: alliances, partner networks and, above all, platforms. These are new to E3 and are covered in the second half of this chapter.

Most of the analytical toolkit you need is familiar; what E3 adds is the ecosystem framing and the tools for networks and platforms:

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2 Drivers of change in the ecosystem

Ecosystems change rapidly, and organisations must adjust if they are to survive. The syllabus groups the drivers of change into five categories:

Sustainability deserves emphasis, because older strategy texts treat the natural environment as a public-relations issue. It is now a driver of change in its own right: governments legislate for net zero, carbon is priced, investors screen for ESG performance, talented employees prefer responsible employers, and customers switch to sustainable alternatives. For some organisations (Chapter 1’s energy companies) sustainability threatens the core business; for others it creates whole new ones. Treating it merely as the ‘E’ in PESTEL understates it.

Notice also that the drivers are linked — they rarely act one at a time. Globalisation spreads technology; technology empowers consumers; consumer and investor pressure accelerates sustainability; sustainability triggers regulation; regulation redraws markets. The banks-and-fintech story in Chapter 1 was regulation and technology acting together; the energy transition is sustainability, regulation, technology and geopolitics all at once. Good ecosystem analysis asks what the drivers will do in combination, and what risks and opportunities that combination creates.

3 PESTEL

We now work from the outside in: first the macro-environmental influences, then influences specific to a particular market, and finally influences specific to a particular organisation within that market. The standard checklist for the macro-environment is PESTEL:

• Political — elections and changes of government, war, trade policy. Politics can be looked at on local, national and geopolitical (international) levels.

• Economic — interest rates, tax rates, exchange rates, inflation, boom or recession. Globalisation belongs here too: many industries are now dominated by relatively few global competitors.

• Social — the main social trend in most Western countries is demographic: lower birth rates and an increasing proportion of elderly people. This affects recruitment, the economics of supporting retirees, and the marketing of products — products suited to older people become more popular.

• Technological — technological changes often come out of the blue, but once a technology exists there is no turning back. Think how the internet transformed the fortunes of travel agents, or how banks have closed branches and moved their customers online — and how quickly generative AI has forced itself onto every board agenda.

• Ecological — carbon taxes and emission restrictions, laws governing air and water pollution, climate change itself (extreme weather, water scarcity) and the expectations that flow from the sustainability driver above.

• Legal — health and safety legislation, equality legislation, consumer protection, data protection and privacy law, regulation of industries.

In the exam you will almost certainly not be asked to explain PESTEL. You will be expected to apply it to specific organisations.

4 Industry convergence

A couple of contemporary environmental influences deserve special mention. The first is industry convergence: industries that were historically separate come together, so that more diverse products or services are offered by the same supplier. Airlines offer car hire, hotels and insurance; supermarkets offer banking.

Technology often drives convergence. Telecommunications has seen landline, mobile, internet telephony, television and film converge; the smartphone alone absorbed the camera, the satnav, the music player and the diary. Convergence can be driven by consumers, who may want one source for a variety of products, or by production — shared technology across products can bring cost benefits. Either way, converged industries tend towards fewer, bigger competitors, and leave less room for small ones.

5 The international dimension

The second contemporary influence is the international dimension. More and more organisations have a global presence. Products and services are converging across countries, which gives producers great cost advantages — purchasing power for materials, and a much larger volume over which to spread research, development and marketing costs. International companies can also manufacture wherever it is cheapest to do so.

But global sales usually mean global competition, and many weaker companies find it difficult to compete in that fierce environment. Because global businesses are large and significant, governments take a close interest: valuable grants may be offered to attract manufacturing plants, and governments may protect home industries against foreign competition.

An awareness of emerging markets can be crucial. There is a risk that a market will not emerge as fully as hoped, but organisations should be wary of missing the opportunities such markets can offer.

6 LoNGPEST

LoNGPEST adds a dimension to PESTEL by analysing the level at which each influence operates: Local, National or Global. When analysing a social influence, for example, the organisation asks whether the change is limited to local areas, to a single country, or is of international importance — and tailors its response accordingly.

7 Government influences

Government is often a powerful and interested stakeholder; its influence is felt particularly through the political, economic and legal elements of PESTEL. Government policies and decisions can affect organisations through:

• Environmental protection requirements

• The level of public expenditure

• Incentive schemes (for example, to set up businesses in certain areas)

• Exchange rates and interest rates

• Tax rates

• Consumer and employee protection legislation

• Legislation on restrictive practices

• Monopolies and mergers legislation

Porter identified seven ways in which a government can affect the structure of an industry:

1. Capacity expansion — for example, encouraging new businesses

2. Demand — more government spending can increase demand

3. Divestment and exit — some governments make it very difficult for companies to close down parts of their operations

4. Control of emerging industries — support and protection in the early years

5. Entry barriers to products — quotas and tariffs

6. Competition policy — intervening, for example, in takeovers and mergers

7. New product adoption — how easily approval is given

8 Porter’s diamond — the competitive advantage of nations

Still on the international dimension: many countries enjoy reputations for certain products and services. Germany is associated with good car making; Japan with electronics and cameras; France with wine; the UK with financial services. Porter asked how nations achieve such reputations, and concluded that four influences interact:

• Factor conditions. Some countries enjoy natural advantages — basic factors such as climate, soil and raw materials. France starts with an advantage in wine because of its climate and soil; Germany’s iron ore and coal supported its engineering industries. Countries can also develop advanced factors: transport infrastructure, telecommunications, education. Germany’s strong tradition of engineering education assists its car industry; Ireland attracts technology companies through advanced factors such as its tax regime, language, EU membership and well-educated young workforce.

• Demand conditions. The first step towards a global presence is a demanding home market. Germany produces good cars partly because German customers demanded solid engineering; Scotland’s heavy woollen cloth grew out of a cold, wet home climate that demanded it.

• Firm strategy, structure and rivalry. A monopoly at home rarely produces a world-beater — monopolists get sloppy. To take on the world you must first be really good at home, and that comes from intense domestic rivalry. Germany’s car industry contains Volkswagen, Mercedes-Benz, BMW and Porsche, all competing with one another, which pushes each towards world class.

• Related and supporting industries. Successful industries sit in clusters. On the American West Coast, software firms, hardware firms and research institutions feed each other, and employees move between them, building a deep pool of expertise. Scotch whisky draws on local grain, peat, cooperage and bottling industries. Clusters make industries efficient — and help their products become differentiated and uniquely good.

A note of realism: the diamond explains how national reputations arose, but it is more descriptive than predictive. A company choosing where to locate today weighs the diamond factors against costs — which is why so much manufacturing sits in lower-cost countries regardless of national reputation.

9 Porter’s five forces

You studied this model in E2. Porter’s five forces analyses industry attractiveness — how easy participants in an industry will find it to make reasonable profits, meaning profits large enough to compensate investors for their risks and to fund the reinvestment that keeps a company successful.

• Competitive rivalry. Competition ranges from perfect competition (many sellers, no choice over price — you charge the market price) to monopoly (much more choice over price — though a monopoly over something nobody wants earns nothing). On the whole, the closer an industry is to monopoly, the easier a time its participants have. That is why companies pursue takeovers, and why competition authorities scrutinise them.

• Buyer pressure. Powerful buyers exert pressure on prices, quality and delivery. Selling almost all output to a few powerful buyers is uncomfortable. The more buyers you have, and the harder it is for them to switch supplier, the better — businesses try to build in switching costs, real costs or impediments that make buyers prefer to stay. Customer analysis is examined in Chapter 9.

• Supplier pressure. If you must buy a special component from a monopoly supplier, you are at their mercy on price. Defences include long-term supply contracts, developing alternative suppliers, or even acquiring the supplier.

• New / potential entrants. Potential entrants sit on the edge of the industry, attracted by good profits. They typically enter with a splash — introductory offers and heavy promotion — forcing incumbents to respond. Anything that keeps them out is a barrier to entry: know-how, high capital requirements, licensing, or (rarely) a legal monopoly. Most barriers slow entrants down rather than stop them.

• Substitute products. Substitutes meet the same need with different technology, and usually arrive as a surprise. Landline telephone companies believed the cost of digging up roads protected them — then mobile technology delivered telephone coverage with much less expense. Once a technology exists it cannot be suppressed; incumbents usually have to join it, which is why conventional telephone companies now run mobile networks.

One 2027-syllabus caution: the five forces assume an industry of pipeline businesses selling to buyers. In platform-based industries the boundaries blur — a participant can be supplier, customer and competitor at once, and the strongest force may be the platform’s own rules. That is the subject of the next section.

10 Strategic networks and platforms

So far the tools have treated the organisation as a stand-alone unit facing its environment. But in a digital world much value is created by networks — groups of organisations and individuals whose products and activities depend on each other — and, in particular, by platforms: businesses whose product is the network. This is the biggest change of emphasis in the modern E3 syllabus. This section introduces the concepts you need for ecosystem analysis; Chapter 7 develops the full strategic toolkit as part of value networks.

10.1 Platforms and two-sided markets

A platform creates value by enabling direct interactions between two (or more) distinct groups — typically producers and consumers — rather than by making a product itself. App stores connect developers with phone users; marketplaces connect sellers with buyers; ride-hailing apps connect drivers with riders; home-sharing sites connect hosts with guests. Because the platform serves two distinct sides at once, these are called two-sided (or multi-sided) markets.

Contrast this with a traditional pipeline business, which buys inputs, adds value in stages and sells outputs. A hotel chain owns rooms and sells nights; a home-sharing platform owns no rooms at all — it orchestrates other people’s. Platforms can therefore scale enormously without owning the underlying assets.

10.2 Network effects

Platforms grow through network effects — the value of the network to each user rises as the number of users grows. Direct (same-side) effects work within one group: a messaging app is useful only if the people you want to reach are on it. Indirect (cross-side) effects work between the sides: more app developers attract more phone buyers, and more buyers attract more developers — the engine of two-sided markets.

Network effects produce winner-takes-most dynamics: once a platform is clearly the biggest, both sides gravitate towards it, and rivals struggle to hold on. This explains why platforms tolerate years of losses to buy growth — market share today is monopoly-like profit tomorrow — and why regulators watch dominant platforms so closely.

10.3 What this means for analysing the ecosystem

When a network or platform sits at the heart of an industry, the ecosystem analysis must ask a new set of questions. Who orchestrates the network, setting its rules and taking a share of every transaction? Who are the other participants — producers, complementors, consumers, technology enablers — and does each side still earn enough to stay? And what is our own participation strategy: build a platform, join one as a producer or complementor, spread the dependence across several (multi-home), or stay a pipeline business and partner selectively?

Stakeholder analysis changes too: in a network, power comes from position — control of the interface, the data and the matching — rather than from size, participants are interdependent (a complementor can be supplier, customer and competitor at once), and the health of the whole ecosystem matters, because an orchestrator that extracts too much value starves the very participants it depends on.

Corporate social responsibility — the remaining topic in this part of the syllabus — is covered with ethics in Chapter 18.

11 Test your knowledge

Two short exercises close the chapter in the online notes: ten flashcards on the terms and frameworks above, and ten practice questions with worked feedback on every option. Work through the cards first, then the questions.